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First Time Homebuyers Guide to Property Taxes

First Time Homebuyers Guide to Property Taxes

Our first time homebuyers guide to property taxes is provided to help new homeowners understand the tax benefits of buying a home.

Things are about to change

Note: Avenue Property Group, LLC and or Keller Williams Realty and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

There’s nothing quite like purchasing your first home. You’re on your own. You have a substantial financial investment. And you now have some different tax considerations. You’re probably well-aware that home ownership affords you several new ways to save on the annual Internal Revenue Service bill.

What you’re probably less sure of is exactly how to go about taking advantage of all your new house-related tax breaks. Many first-time homeowners will definitely enter new tax-filing territory with the very first return they file after moving into their new abode. For other new owners, the filing changes might take a little longer to show up. But all will need to know some basic tax rules that could make their homes a great tax — as well as an actual — shelter.

You survived the house search and the bidding process. Getting the mortgage on your new home was a piece of cake. But now you’ve got to file your tax return for the first time since you moved into your first home. Relax.

Welcome to Schedule A

As a homeowner, regardless of whether you’re a first-timer or have owned many residences, you probably immediately think “deductions” when it comes to tax time. That’s because you now have the chance to claim several expenses you didn’t face as a renter. The big-three home-related deductions are mortgage interest, any points connected with the loan and property taxes.

Schedule A
Schedule A

To claim these, you’ll have to itemize. This deduction method, which requires filing the long Form 1040 and detailing your various deductible expenses on Schedule A, is often a new experience for first-time homeowners. However, before you rush off to download this new tax paperwork, take a few minutes to evaluate your overall filing circumstances. While many homeowners do benefit by itemizing, that’s not the case in every situation. You want to make sure that the deduction method you choose is the one that gives you the larger deduction amount.

If you find that the standard deduction, which on 2023 taxes is $13,850 for single taxpayers and $27,700 for married couples filing a joint return, is greater than the total of your itemized expenses, then by all means take the standard deduction. Don’t worry, you’re not stuck using that method forever. You can alternate between the two deduction options every year or you can itemize for several years, claim the standard amount for a few more and then return to itemizing. The key is to always pick the deduction method that will give you the most tax savings for each filing year.

Making the most of mortgage interest

If you do find that itemizing is the way to go, your largest write-off is probably going to be the interest you paid on your mortgage. This is a particularly valuable tax break in the early years of a home loan, when most of your monthly payments go toward interest charges.

A common private home-loan is one obtained through seller financing, where you make your monthly payments to the seller instead of a traditional lender. Interest paid to the seller is deductible, as long as the loan is established using the same guidelines as for a conventional bank mortgage.

Again, you need to be sure this is documented properly (it’s probably a good idea to have an experienced real estate lawyer help you set up this arrangement) and that an appropriate interest rate is charged. But as long as the money is secured by the house, it’s a mortgage, and the interest is deductible.

Hang onto your Closing Disclosure

Closing Disclosure
Closing Disclosure

Regardless of who holds your mortgage, the lender should send you a Form 1098 or similar document in January. This will list all the interest you paid over the previous tax year. You report that interest amount on either line 10 or 11, depending upon the mortgagee, of your Schedule A. New homebuyers, however, shouldn’t rely solely on that 1098 information.

“It is possible that for a new homebuyer, the amount on the form is not quite accurate,” says Benny L. Kass, who practices law in the Washington, D.C., area with the firm Kass, Mitek & Kass PLLC. “You settle on July 10,” says Kass. “Your first payment typically will be due Sept. 1. When you make that payment, you will pick up interest for the month of August. But since you borrowed on July 10, many lenders will charge interest from the 10th to the end of July. That amount covering those days in July is deductible.”

Not all lenders, however, will include that initial adjustment of interest for that first month, July in this case, says Kass. “Make sure you pick that up.” You’ll find that added amount of interest on your closing statement, usually referred to as the Closing Disclosure (formerly known as the HUD-1 Settlement Statement).

Points pay off at tax time

Your Closing Disclosure, and probably the 1098 you’ll get from your lender, will list any points you paid for your mortgage. A point is 1 percent of your loan amount. Buyers sometimes choose to pay points to obtain a lower interest rate. The IRS allows you to deduct points for the tax year in which you purchase the home. You include the points paid in the same section of Schedule A where you claim your mortgage interest.

For a purchase of a principal residence, you can choose to amortize or deduct the points all at once. Most people, and usually first-time buyers, are going to fall into the category of claiming it all at once. This means if you paid 1.5 points on a $200,000 home loan, that $3,000 will go directly toward your itemized deduction amount.

But don’t be concerned if you don’t see the term ‘points’ on the settlement sheet. This amount could be called ‘loan origination fee,’ ‘loan discount fees’ or ‘points’. The name is not important. What is important for most loans is they are fully deductible by the new homebuyers as long as they are reasonable and consistent in the area where you bought the home.

The tax law requirement that points be in line with your real estate market is yet one more reason to avoid lenders who charge exorbitant amounts. Ten points is probably not consistent or reasonable anywhere but some loan sharks are charging that. Another nice tax feature of points: Even if the seller paid them, the buyer generally gets to claim the deduction.

The tax-deduction value of property taxes

The third major home-related tax deduction is real estate taxes. In Texas, homeowners can actively leverage the valuable deduction provided by property taxes, significantly reducing their tax burden. This deduction serves as a crucial incentive for property ownership, enabling individuals to claim a portion of their property taxes paid as a reduction in their taxable income.

By utilizing this deduction, homeowners actively lower their overall tax liability, thereby managing their finances more effectively and freeing up resources for other essential expenses or savings. Moreover, this active utilization of the property tax deduction stimulates investment in real estate, fostering economic growth and stability within local communities across the Lone Star State.

Timing is everything

Now that you know all the new-home-related deductions you can claim, you’ve probably already gone to Bankrate’s tax form library to download a Schedule A. Not so fast. With taxes, timing is everything. While in most cases homeowners will benefit from itemizing, the time of year when you actually closed on your house could make a big difference in your deduction method choice.

Not everybody should consider itemizing. If you settle later in the year, you’ll have very few deductions for mortgage interest and taxes, so it might be better to use the standard deduction amount. New homebuyers should ‘run it both ways’ to see if, by itemizing their deductions, they will exceed the standard deduction amount.

When calculating your itemized deductions, also be sure to count other non-housing items. For example, you can now take tax advantage of any charitable contributions you made in the year that you bought your house. Young people buying their first home usually don’t worry about keeping records of charitable donations because they’ve been using the standard deduction for years. Now they can add those contributions to the deductible costs associated with their new home to come up with a larger itemized deduction amount.

And remember those points you paid? If you find that you can’t itemize for the year you bought your home, you can amortize them. You’ll simply spread the points over the life of the loan and deduct the appropriate amount in each future year you itemize your deductions. If you have a 30-year mortgage, that $3,000 in points in the example cited earlier, would give you $100 to deduct each tax year that you itemize.

Other deductions, thanks to your home

Some new homeowners also might elect to take out a small home equity loan or line of credit in connection with their new residences. While considering taking on additional debt tied to your residence is a personal financial decision that requires careful consideration, if you do obtain such credit, ensure that you actively capitalize on its tax benefits. Interest on home equity loans and lines of credit is deductible when the borrowed funds are used for purchasing, building, or substantially improving the home that secures the loan.

Did you buy the house after moving to take a job? Then you also might be able to write off some relocation expenses. If the move was either to start a new job or your current office relocated you to a new location more than 50 miles from your old job some of those expenses might be deductible. Alternatively, if you are self-employed and working out of your house, home office deductions might apply.

And if you make home improvements for a medical purpose, those expenses are fully deductible only if they don’t cause your home’s value to rise. If a remodel boosts your home’s value, then you have to subtract the increase in value from the cost of the improvement. The result is the portion of your spending that can qualify for the medical deduction.

What’s not deductible

But don’t get carried away with writing off any and everything connected to your home. Many things you’ll see listed on your Closing Disclosure, such as appraisal charges, title insurance, and credit report fees are not deductible on your federal tax return.

Neither is private mortgage insurance that your lender might have required you to purchase — unless you took out the loan (or refinanced) on or after Jan. 1, 2007, when a new law took effect which enables some homeowners to deduct PMI. Homeowners association fees are not deductible either.

You also need to pay attention to some more local tax matters connected to your home. Property-tax exemptions, for example, could help lower your annual property tax bill. While this will mean less to deduct when you file your annual federal tax return, that’s usually a trade-off homeowners will gladly make in order to have more money in their personal accounts the rest of the year.

Exemptions have to do with how much property tax you’re ultimately paying. The taxes are assessed on the value of your house. It may be worth $400,000, but if you get a $100,000 homestead exemption, you will be paying taxes on just $300,000 of value.

The types and amounts of homeowner real-estate-tax exemptions vary greatly across the United States. Check with your local officials about what’s available and what you need to do to qualify for the exemptions. Even before you buy, you should find out from your closing officer, real estate agent or county officials what exemptions and deductions you get.

Planning ahead

After you finish your first tax return as a homeowner, use it to plan for the next one. In early December ask yourself, ‘Do I need more deductions this year?’ ‘Am I making more money this year or will I next year?’ ‘Can I prepay my January (mortgage) payment and real estate taxes in December?'”

At the end of the year, if you feel you can use an added mortgage interest deduction this year instead of the next year, as long as you make the payment early (by Dec. 31), you can deduct it. The same with property taxes. Pay them this year to deduct them on your next return.

Also be sure to hang onto your Closing Disclosure. Remember all those charges you couldn’t deduct on your return? They can be added to your home’s basis. The basis, which is the total of your purchase price plus closing costs plus any substantive improvements you make to the residence, is what you subtract from the sales price you receive to determine your profit.

Capital Gains Taxes

Capital improvements are things like putting on a new roof, redoing the kitchen, remodeling the bathroom. A lot of people do these things even before they move in. They’re not deductible this year but might help you when you sell the house in terms of how much capital gains you have to pay. If you’re single, you can make up to a $250,000 profit on your home and not owe any taxes on the money as long as you’ve lived in the house two out of the last five years prior to the sale.

Couples who file jointly get twice that exclusion amount. If your home’s value appreciates substantially, the items added to the basis, if you keep track of it, could help you keep your profit in the tax-free range. Set up a record-keeping system that helps you track your home-related costs and does so in a way you can retrieve the information if the IRS wants to get a look at it.

Lastly, absolutely hang onto to Closing Disclosure for three years after you sell your last house. That’s how long the IRS has to come back and look at your return. But even if you have no audit concerns whatsoever, it’s a good idea to hold onto this document since it’s a record connected to what’s probably your largest personal investment.

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