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Home Buying 101

Doing the Prep Work

How Home Ownership Affects Your Taxes

Your new home might offer up some “found” savings when it comes time to file your annual income tax return. The federal homeowners deduction is one of the perks of ownership and is often cited as a rationale in favor of buying rather than renting a home. Here’s how it works.

Deducting All That Interest
Mortgage interest is 100% deductible on home loans of up to $1 million ($500,000 if married couples file separately). Homeowners may also deduct interest paid on up to $100,000 of home equity debt.

Further deductions include property tax and private mortgage insurance (PMI), which is insurance required on loans taken out with less than 20% down payment. And finally, if you paid points down at the time of closing to lower your interest rate, you can deduct them over the life of the loan.

What’s Not Deductible?
Although required by most lenders, homeowners insurance that safeguards your home from fire, flood, or other damages is not deductible from your annual income. The same goes for your initial down payment and closing cost fees.

Should You Itemize?
Tax deductions are not a dollar-for-dollar savings, but deducting your interest, PMI, and property taxes from your taxable income reduces the amount of tax you’ll owe at the end of the year. For example, if you gross $80,000 a year and you’re paying $7,200 annually in interest, plus $960 PMI and $1,000 in property taxes, your homeowners deduction totals $9,160, which reduces (or adjusts) your annual taxable income to $70,840. This means you’ll pay tax on the lesser income amount, saving you money.

But before you start planning how to spend that savings, you’ll need to consider whether the standard allowable deduction exceeds your homeowners deduction plus other deductible expenses, such as charitable contributions and health care costs. (In 2011, the standard deduction was $11,600 for those filing jointly, $5,800 for single filers, and $8,500 for heads of household.) If you don’t have other itemized deductions to take and your total expenditure in interest, PMI, and property taxes is less than the standard deduction, you won’t reap benefits from itemizing.

It All Adds Up
So how much can you save? The amount varies based on your financial situation. You should always consult a C.P.A. or qualified tax advisor to determine whether itemizing or claiming standard deductions is more beneficial for you. How much you’ll save is related to how much you earn.

Homeowners deductions can sweeten the pot when you’re considering the purchase of your first home. Yet it’s not a given that writing off your mortgage’s interest, PMI, and property tax will lower the amount you owe in taxes or get you a large return.

Find out more about the tax advantages of home ownership at: irs.gov/publications/p530/ar02.html.