Personal Finance Essentials
Tax Considerations for Homeowners
Homeowner Tax Strategies:
Maximize Your Deductions and Savings
Mortgage Interest Deduction
The interest you pay on a mortgage used to purchase your home is generally tax-deductible on the interest accrued on up to $1 million of acquisition debt — money borrowed specifically to buy, build, or substantially improve your primary or secondary home. This deduction makes your effective interest cost lower than the stated rate. A 7% mortgage for someone in the 25% tax bracket actually costs about 5.25% after the deduction.
Investment returns are taxed at the capital gains rate — typically 15% for long-term gains — which is lower than most income tax rates. This means that even if your investment portfolio earns the same 7% as your mortgage costs, your after-tax investment return exceeds your after-tax mortgage cost. The math favors investing over paying down the mortgage.
Refinancing and the $100,000 Limit
When you refinance and take cash out, the tax rules are different. The interest on cash-out refinancing is deductible only on the first $100,000 of new debt above your original acquisition balance. This limit does not apply if you are using the proceeds for home improvements. For example, if you have a $50,000 remaining balance on a home worth $400,000, you can refinance up to $150,000 and deduct all the interest. Anything you borrow above that generates non-deductible interest. This is one reason to get the largest mortgage you can at the time of purchase rather than afterward.
Restrictions on Investing Refinancing Proceeds
If you borrow against your home equity, you cannot invest those proceeds in tax-deferred or tax-exempt accounts. This includes annuities, municipal bonds, and 529 college savings plans. Violating this rule causes your mortgage interest to become non-deductible. Keep this in mind when planning how to deploy cash pulled from a refinance.
Points Deductions
Points paid when purchasing a home are fully deductible in the year you pay them. Points paid on a refinance must be deducted over the life of the loan — typically 1/30th per year on a 30-year loan. However, if you refinance again before the original points are fully amortized, you can deduct all remaining unamortized points in the year of the new refinance. Many homeowners miss this and leave significant tax deductions unclaimed.
Property Taxes
Property taxes are an ongoing cost of home ownership. They represent a continuous drain on household wealth and should be factored into any calculation of the true cost of owning a home. They do not disappear when the mortgage is paid off.