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Home Buying 101

Doing the Prep Work

How Home Ownership Affects Your Taxes

Did you know that 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 home 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

Usually 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). PMI is insurance that is required on loans taken out with less than 20% down payment. PMI may be deductible if your adjusted gross income is less than $100,000. 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. These tax deductions are typically allowed for most individuals, however, be sure to check with your tax advisor.

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 costs.

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. (For the 2012 tax year, the standard deduction is $11,900 for those filing jointly, $5,950 for single filers, and $8,700 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.