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Most of the time when you buy a home, you get a few perks beyond just becoming a homeowner. For example, the government has an interest in keeping the housing market strong and encouraging people to buy homes — that’s why there are federal and state tax credits available to both first-time and regular homebuyers.
That said, the first-time home buyer tax credit implemented under the Obama administration no longer exists. So, if you’re looking for tax credits, they aren’t quite as cut and dry as they used to be for first-time home buyers.
Still, tax credits do exist for all types of homebuyers as long as you know where to look and how to file your taxes. Plus, there’s some hope that a stronger first-time home buying tax credit will return if the First-Time Homebuyer Act of 2021 passes in 2022.
What is the First-Time Homebuyer Act of 2021?
Introduced in April 2021 by several Democratic members of Congress, the First-Time Homebuyer Act of 2021 aims to bring back the Obama-era tax credit for first-time home buyers from 2008. The name is a little misleading as the bill has not yet been signed into law, so it may ultimately change to the First Homebuyer Act of 2022.
Under the proposed bill, eligible homebuyers could receive a tax credit of up to 10% of their home’s purchase price, up to $15,000.
Although eligibility requirements could change before the bill is signed into law, the current requirements are:
- You cannot have owned a home or co-signed on a mortgage within the past three years. This includes both primary residences and second properties.
- You cannot use the tax credit more than once. However, homeowners who used the 2008 first-time homebuyer tax credit may be eligible for the 2021 (or 2022) credit.
- Homebuyers cannot have an income more than 60% above the median income in their desired purchase location. Income requirements are higher for joint filers and individuals with multiple income streams.
- First-time homeowners must be at least 18 years old.
- Homebuyers cannot claim the credit if they purchased a home from a direct relative.
The new tax credit stands to work similarly to the 2008 credit. Eligible homebuyers may receive a loan for an amount equal to 10% of their home’s purchase price — up to $15,000. Once received, the tax credit would automatically apply to your federal tax bill without a formal application. However, you might have to file a separate IRS form with your federal tax return.
The proposed bill says that if you own your house for at least four years, you don’t have to repay the tax credit. If you sell your home or move within the first four years of ownership, you must pay back a portion of the tax credit, based on the length of ownership. (Keep this in mind when considering how soon to sell your home after buying it.) There are exceptions for death, divorce, military transfers, and transactions in which you profit less than your tax liability.
Tax credits for first-time homeowners
While this proposed bill is the most exciting potential credit for first-time homebuyers, it doesn’t exist as of this writing. So, if you’re looking to buy your first home in the near future, there are other ways you can find tax credits.
Most states offer first-time home buyer programs that include tax credits, and may even provide zero-interest loans and grant money to put toward a down payment.
In Texas, for example, the Texas State Affordable Housing Corporation offers mortgage tax certificates that let you deduct a large portion of your mortgage interest on your annual federal tax return.
Most state programs have a maximum limit on income and property value since they cater to lower-income buyers, but they’re worth checking out to see if you qualify.
If you have a Roth IRA or traditional IRA, first-time homebuyers are also allowed to take up to $10,000 out of their accounts to buy a home. Each account has different rules and tax consequences, so if you need a little extra help with your down payment, discuss this tool with your real estate agent before pursuing it.
Common tax credits and deductions for all homeowners
While there are relatively few tax credits specific to first-time home buyers, all homeowners have access to a litany of tax credits and tools to save some money. Here are some of the most common:
Property tax deduction
The most common tax break for homeowners is the property tax deduction. Property taxes range wildly from place to place and can make up a significant portion of your mortgage payment. Most homeowners, however, can deduct some of those taxes.
You must itemize rather than take the standard deduction and there are a couple of other wrinkles. For one, there’s a $10,000 limit ($5,000 if married filing separately) on the combined amount of state and local income, sales, and property taxes that you can deduct on your return. Once you’re over $10,000, it’s non-deductible. Where property taxes are high, that limit hurts.
Mortgage interest deduction
If you itemize your deductions rather than take the standard deduction, you can deduct interest on up to $750,000 of debt ($375,000 if married filing separately) used to buy, build, or substantially improve your primary home or a second home. (“Substantial” improvements are ones that add value to the home, extend the home’s useful life, or adapt the home for new uses. Most additions and major renovations are substantial improvements.)
Mortgage interest credit
Lower-income homeowners who were issued a qualified Mortgage Credit Certificate (MCC) from a state or local government to subsidize their home purchase may claim a mortgage interest credit in addition to the interest deduction. The mortgage interest credit ranges from 10% to 50% of mortgage interest paid during the year and capped at $2,000 if the credit rate is higher than 20%.
This credit has many rules and restrictions, the biggest being that you need a qualified MCC. Also, you can’t claim the credit more than once, so if you claim the mortgage interest credit, you must reduce your mortgage interest deduction by the credit amount.
Mortgage points deduction
When you take out a mortgage, you usually have to pay “points” to the lender that are basically an upfront fee for securing the loan. In most cases, however, those points you pay on a loan are fully deductible in the year you pay them.
If you’re buying a second home, you can’t deduct the points in the year you pay them. Instead, you must deduct them gradually over the year of the loan. For instance, if you paid $1,000 in points for a 30-year mortgage, you can only deduct $33 a year for the lifetime of the mortgage.
In order to claim a mortgage points deduction, you must reject the standard deduction and include it in your itemized deductions on your tax return.
Home office expense deduction
A popular tax break with so many people working from home these days, the home office deduction is available to both homeowners and renters. Basically, if you work at home, you can deduct anything you use regularly and exclusively for work.
Calculating this deduction gets a little tricky since you have to multiply the expenses of operating your home by the percentage of your home devoted to business use. The “simplified” method deducts $5 for every square foot of space in your home used for qualified business purposes. Technically, though, you’re entitled to deduct part of your utility bills, insurance costs, materials, general repairs, and much more that will easily surpass $5 per square foot. Documentation and proof, however, is something of a nightmare.
Energy-saving improvement credits
Go green, get rewarded! If you install certain energy-efficient equipment in your home, you can save 26% on qualifying new systems that use solar, wind, geothermal, biomass or fuel cell power. Installing energy-efficient insulation, doors, roofing, HVAC, water heaters, and other home essentials can also net you a tax credit of up to $500.
Rental expenses deduction
If you rent out part of your home, you must pay taxes on your rental income, but you can also deduct expenses for managing the rental space. Expenses like insurance, maintenance costs, real estate taxes, utilities, and supplies all count as deductible.
Like the home office deduction, however, it gets tricky to calculate how much you can actually deduct. Since you can’t deduct the entirety of the electrical bill, you have to allocate it to just the percentage of your home that you rent out.
The home sale tax exclusion
This final credit is for sellers, not buyers, but it’s worth knowing. When you sell your home, you may be entitled to write off up to $500,000 ($250,000 for single filers) of profit. The Home Sale Tax Exclusion protects you from capital gains tax if:
- You’ve owned the home for at least two of the past five years.
- You’ve lived in the home for at least two of the past five year.
- You haven’t used the exclusion to shelter gain from a home sale in the last two years.
The IRS doesn’t give many gifts, but this is a big one. So if you’re buying a home in a hot market, bear in mind you have to stay there for a while before trying to flip it. Otherwise, you’ll get hit with a hefty capital gains tax bill.
Pending the passage of the First-Time Home Buyers Act of 2021 (or 2022), there aren’t many great tax credits for just first-time home buyers. State programs exist, but they’re rarely as compelling as federal offers. In the meantime, however, homeowners can leverage a number of deductions and credits to help save a little money come tax time.