It’s better to plan ahead than to have your savings account be squeezed down the road by unexpected tax policy changes.
A Tax-Saving Guide for First-Time Homebuyers
Buying a home is a watershed moment in life. So many changes — suddenly you’re building equity, planning renovations and maybe even basking in the pride of homeownership. Another big shift? How you file your taxes as a new homeowner.
Featuring the most up-to-date information from the IRS' website, here are four essential yet practical tips for keeping up with your tax responsibilities as a first-time homeowner.
1. Stay up-to-date.
Tax laws aren’t set in stone. There are revisions, additions and subtractions — big and small — on a regular basis. So you’ll need to be aware of these modifications and make adjustments to your budget and savings plans as necessary.
The following are a few examples from the current federal tax code that could have a significant financial impact on new homeowners:
- Homeowners can only write off up to $10,000 of what they pay in state income and local property taxes This is no doubt of particular interest to those who reside in high-tax states such as New York, New Jersey and California.
- New home loan mortgage interest deductions are limited to $750,000. Borrowers may recall that before 2018 the limit was $1 million. People in low to moderately priced homes likely won’t be affected by this change, but those in more expensive homes or cities could be.
- A home equity loan allows individuals to borrow money against the value of their home. As of 2020, interest on a home equity loan is deductible only if the funds from the loan are used to buy, build or improve the home that secures the loan. For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debt, isn’t. Keep in mind that taxpayers can only deduct interest on up to $750,000 in eligible loans — primary mortgages, home equity loans and vacation home loans combined. The IRS provides more guidance here.
One important note: The above examples only affect taxpayers who itemize on their tax return.
2. Keep taxes in mind when creating your new housing budget.
A successful new homeowner budget includes far more than the mortgage payment. In addition to property taxes, there are higher utility bills, homeowner’s insurance and potential HOA or condo fees to consider. Keep in mind both the current tax rates and the trajectory of taxation in the states, towns and cities on your home shopping wish list. Leave space in your budget for potential tax increases. It’s better to plan ahead and not need that extra cushion than to have your savings account be squeezed down the road by unexpected policy changes.
If you plan to take itemized deductions come tax season, it’s essential you understand the ins and outs of what can and cannot be written off. For example, any modifications that are made to your home for medical purposes — such as adding wheelchair ramps or lowering cabinets for accessibility — can be deducted, but purely cosmetic renovations cannot. If you work from home, certain deductions can also be made for home expenses that are associated with your work, such as home office furnishings and utilities. Additionally, if you relocate for a new job, you may also be able to take a deduction for certain moving expenses. A qualified accountant can help you better understand which home deductions may legitimately lessen your tax load.
4. Think twice before dipping into your retirement savings to fund your down payment.
While the IRS does allow penalty-free withdrawals of $10,000 from a traditional IRA for first-time homebuyers, it’s wise to proceed with caution: For starters, withdrawals are penalty-free but not necessarily tax-free — and the exact rules get tricky. In general, traditional IRA withdrawals are subject to ordinary income taxes. The rules for a Roth IRA are different. People with a Roth IRA can always withdraw contributions tax- and penalty-free, although earnings are subject to the $10,000 limit. However, while contribution withdrawals are tax-free on a Roth — as well as withdrawals of earnings up to $10,000 under the homebuyer exemption — withdrawals of more than $10,000 in earnings from a Roth will be subject to ordinary income taxes plus the 10% penalty. If you’re hoping to put down 20% on your home, securing an extra $10,000 from your retirement fund may not be worth racking up the fees in the process. It’s best to consult with a tax professional and/or financial advisor before tapping your retirement savings to fully understand which fees you may incur as well as how doing so may affect your other short- and long-term financial goals.
First-time homebuyers need to take many factors into account before signing on the dotted line — and taxes are an important piece of that puzzle. If you’re confused at all about the new tax changes or how buying your first house will affect your taxes, speak with a tax professional and a financial advisor before making any decisions.