Personal Finance Essentials
Taxes and Your Home
Your Home Is Your Biggest Tax Asset
Unless You Make One of These Costly Mistakes
Your home creates several important tax situations – some beneficial, some potentially problematic if mishandled.
The Mortgage Interest Deduction
Mortgage interest is generally tax-deductible, making a home mortgage one of the least expensive forms of borrowing available. When you take out a mortgage to purchase a home, the interest on the entire loan is deductible. When refinancing, however, only the interest on debt used to buy, build, or substantially improve the home is deductible. Under the Tax Cuts and Jobs Act (TCJA), interest on cash-out refinancing proceeds used for other purposes is not deductible. Total acquisition debt is capped at $750,000 for loans originated after December 15, 2017 (or $1,000,000 for loans originated before that date).
Consider what this means in practice. Suppose you have a $50,000 mortgage on a home worth $400,000 and you refinance to a $300,000 loan to access equity. The interest on only the $50,000 of original acquisition debt is deductible – the interest on the remaining $250,000 cash-out (used for non-home purposes) is not deductible under current law.
Because mortgage interest is tax-deductible while principal payments are not, longer-term loans can offer meaningful tax advantages over shorter ones. A 30-year mortgage carries a higher proportion of interest in each payment than a 15-year mortgage, providing a larger deduction year after year.
Avoiding Capital Gains Traps
Adding a child’s name to your property – a common shortcut people use to simplify inheritance – can create an unexpected capital gains problem. When someone inherits property, they typically receive a step-up in basis: their cost basis is the property’s market value at the date of the original owner’s death, and no capital gains taxes are owed on appreciation that occurred during that owner’s lifetime.
But if you add a child as a co-owner during your lifetime, that step-up in basis is lost for the child’s share. When the property is eventually sold, capital gains taxes will be owed on the full appreciation since the original purchase. On top of that, the IRS may treat the child as owning 50% of the asset – potentially creating a taxable gift where none was intended. Proper estate planning, rather than title shortcuts, is the better path.