By Kirk Haverkamp Provided by
What federal tax deductions can you take for a mortgage and other home ownership expenses? With tax season at hand, it's a good time to take a fresh look at the rules for the 2012 tax year (filing in 2013).
Tax deductions vs. tax credits
Two major things before we start. First, the fundamental rule is that you can't deduct anything unless you itemize deductions. And it doesn't make sense to itemize unless your total deductions exceed the standard deduction the IRS allows you automatically. For 2012, the standard deduction is $12,200 for couples filing jointly, $6,100 for single filers, and $8,950 for a single head of household.
The second major thing is that you can claim tax CREDITS regardless of whether you itemize deductions or not. Tax deductions and tax credits are two different animals, but many people confuse the two. Tax deductions allow you to reduce your taxable income, while tax credits reduce your tax bill itself. Mortgage interest is a tax deduction, for example, while certain home energy improvements provide tax credits.
It should also be noted that these are rules for federal taxes. Although many of them will be used in determining your adjusted gross income (AGI) that is typically used as the starting point in figuring state income taxes, their specific application may vary from state to state.
Mortgage interest deduction explained
The #1 deduction, of course, is the mortgage interest deduction. You can deduct mortgage interest paid on loan balances of up to $1 million for a mortgage used to purchase or improve your primary residence. You can also deduct mortgage interest for a second home as well, up to a total loan balance of $1.1 million on your primary and secondary homes combined (The deduction is limited to two properties; third homes and beyond are not eligible).
You can also deduct the mortgage interest paid on up to $100,000 in home equity loans on your principle residence. However, you can't claim this deduction if you're subject to the alternative minimum tax (AMT), unless the loan was used to repair or improve the property.
Rules for discount points
If you bought discount points when you took out your mortgage, those are tax-deductable as well, since they're considered mortgage interest paid in advance. The way you deduct points, however, depends on the type of loan and how you paid for them.
Discount points paid for as part of a home purchase are generally tax-deductable in the year you paid for them. So if you bought a home in 2012 and paid for discount points up front, you can deduct the total amount of those points on your upcoming tax return. However, if you rolled the cost of those points into the loan, the IRS requires that you deduct them on an amortizing basis, since that's how you're paying for them.
If you bought points as part of refinancing a mortgage, in most cases you'll only be able to deduct those on an amortizing basis, even if you paid for them separately up front.
Other fees paid as part of closing costs for a mortgage or home sale are not tax-deductable.
About second homes
For purposes of the mortgage interest deduction, your second home can be a boat or RV, as long it's equipped with sleeping quarters, a bathroom and cooking facilities. You can rent out the property part-time and still take the deduction as long as you use it at least 14 days a year or at least 10 percent of the number of days it is rented out, whichever is greater. Otherwise, you have to declare it as income property.
If you rent your home or boat out for less than 14 days a year, you do not have to declare the revenue as income on your tax return. Lease it for more than that and you have to declare the income, but you can also begin to deduct other costs and losses as business expenses. The rules for these can get complicated, though, based in part on how much time you use the property vs. renting it out.
Property taxes, dues, insurance and PMI
State and local property taxes are deductable for any number of homes you own; unlike the mortgage interest deduction, this deduction is not limited to your first two homes. The tax must be charged uniformly across a jurisdiction, so special assessments such as for sewage improvements along your street are not eligible.
If you have a condominium, your association dues are not tax-deductible, even if billed as part of your mortgage.
Homeowners insurance is not tax-deductable, even if it is required under the terms of your mortgage and is paid as part of your monthly mortgage statement.
Private mortgage insurance (PMI), paid if you put less than 20 percent down on your mortgage, is tax-deductable only for mortgages obtained in 2007 and beyond. If you took out a mortgage prior to 2007 but refinanced it in 2007 or later, PMI paid on the new loan is tax-deductable. This deduction had expired, but was revived for 2012 and extended through 2013 as part of the fiscal cliff negotiations.
Home office deduction
The home office deduction is a fairly common one, but comes with some specific rules. The main one is that you must use the office for your business exclusively – no hanging out after hours to catch up with friends on Facebook, or using a corner to store Christmas decorations. It must be a place of business exclusively.
That being said, if you meet that standard you can deduct whatever portion of your home expenses can be attributed the office. So if your home office is 144 square feet (12'x12") and you have a 1,440 square-foot home, your home office is 10 percent of the home and therefore 10 percent of expenses.
You can therefore deduct 10 percent of your heating and electrical bills, monthly mortgage principle, mortgage interest and other ongoing costs for the whole home as business expenses. If you pay someone to mow the lawn, you can deduct 10 percent of that, or 10 percent of the cost of a new roof if you have to put that on. Bear in mind, though, that your home mortgage interest deduction will be reduced by whatever portion is attributed to your home office.
Energy efficiency tax credits
The fiscal cliff agreement also extended tax breaks for home energy efficiency improvements through 2013. These are tax credits, reductions off your tax bill, so you can claim them even if you do not itemize deductions.
You can get up to a $500 credit for energy-efficiency improvements such as a new furnace, hot water heater, windows, insulation, certain types of roofing or other qualifying improvements. The improvements must be to your primary residence and pre-approved products must be used.
The credit is 10 percent of the purchase cost, up to $500 maximum. The $500 cap is a lifetime limit, so if you took a $300 energy efficiency credit previously, you can only take up to $200 this year or next. Installation costs are allowed as part of the purchase price on certain items.
There are also separate programs that allow credits for geothermal heat pumps, small wind turbines, solar energy panels and residential fuel cells. These provide tax credits of up to 30 percent of the cost of the system, capped at $500 for fuel cells but unlimited for the others. The credit for heat pumps, wind turbines and solar panels may also be used for second homes.
A final word
Tax laws are, of course, complex. All of these deductions have additional rules that are not covered here but which could trip up the unwary. You may also be able to qualify for other home- or mortgage-related deductions that are not listed here. Be sure to check with the appropriate IRS publications, your accountant or other tax professional, or the guidance in your tax-preparation software before taking any deduction or credit on your return.