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 of being a homeowner? How you file your taxes.
Using the most up-to-date information from the IRS' website, below you will find four practical, essential tips for keeping up with your tax responsibilities as a first-time homeowner.
Tax Tip No. 1: Stay up-to-date
Tax laws are not 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 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 previous limit was $1 million. People in low to moderately priced homes likely won’t be effected by this change, but those in more expensive homes or cities could be.
- Currently, home equity loan interest is no longer deductible. Under the previous law, it was deductible up to $100,000.
One important note about these examples: The above really only affects taxpayers who itemize on their tax return.
Tax Tip No. 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 also higher utility bills, homeowner’s insurance and potential HOA or condo fees to consider. Keep in mind both current tax rates as well as 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.
Tax Tip No. 3: Know what constitutes a home deduction — and what doesn’t
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 be 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 and you meet the IRS distance and time tests, you might also be able to take a moving-expense deduction. A qualified accountant can help you better understand which home deductions may legitimately lessen your tax load.
Tax Tip No. 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 is 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 might 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 what fees you might incur as well as how doing so might affect your other short- and long-term financial goals.
The Tax Takeaway
First-time homebuyers need to take many factors into account before signing on that dotted line—and taxes are an important piece of that puzzle. If you’re confused at all about new tax changes or how buying your first house will impact your taxes, speak with a tax professional and a financial advisor before making any decisions.