New (and Old) Tax Breaks for Homeowners
It’s no secret that homeowners can qualify for favorable tax treatment. Mortgage interest is tax-deductible during home ownership, and all or a portion of any capital gains on a personal residence is exempt from taxation when it is sold. These benefits have enabled many Americans to not only achieve the dream of homeownership, but also buy a more costly home than they would have without the tax breaks and build wealth for their own future and for that of their heirs.
However, in the current environment, the tax breaks may not be as widespread as many people think. Also, there are additional tax breaks, especially for energy-related home improvements, that may not be widely known or understood. It’s worth taking a look at them to see what we may be missing…or not.
The Home Mortgage Interest Deduction
Tax savings from the mortgage interest deduction is not as common as many people might think because mortgage interest can only be taken as an itemized deduction. Under current tax law, the standard deduction, which is available to taxpayers whether they have a mortgage or not, is, for most people, higher than the total of a homeowner’s itemized deductions. According to the Tax Policy Center, only about 10% of taxpayers currently itemize their deductions compared to about 30% before the 2017 tax bill, which roughly doubled the amount of the standard deduction while eliminating the personal exemption. (Most of the provisions of the 2017 tax law are set to expire after 2025, but many of them may be extended by Congress.
Another factor reducing the use of itemized deductions has been the level of interest rates. Until early 2022, the 30-year fixed mortgage rate was mostly below 5% for almost two decades and even dropped for a short time below 3%, enabling new buyers and refinancers to lock in low payments, which has had the effect of bringing their total itemized deductions below the standard deduction. Also lowering the total of itemized deductions for some homeowners is the limit on the dollar amount of state and local taxes that can be deducted.
As a result, the deductibility of mortgage interest mostly benefits homeowners with large mortgages and high incomes. The higher one’s tax bracket, the greater the tax savings, which is a function of the size of the deduction and the marginal tax rate. Some economists have proposed that the mortgage deduction be replaced with fixed dollar credit available to those at any income level.
Capital Gain on the Sale of a Personal Residence
For many years and until 1997, there were no capital gains taxes on the sale of a personal residence so long as the proceeds were “rolled over” to another personal residence within a certain length of time. Once a homeowner was over age 65, there was a one-time capital gains exemption of $125,000.
Under current federal tax law, home sellers can no longer avoid taxation by “rolling over” their gain to a new home. But home sellers of all ages can apply a more generous exemption to the amount of the gain. It is $500,000 for a married couple filing a joint return and $250,000 for a single taxpayer, so long as the house was the owner’s personal residence for at least two out of the last five years. Any gain above that is taxed at capital gains rates. (There are exceptions for job-change required home sale or divorce situations if other requirements are not met.) The capital gain can be reduced by adding the costs of qualifying home improvements over the years to the original price of the home, which increases the cost basis. That’s why it is very important that any documentation from home improvements be saved.
Home Office Deduction
If someone uses a space in their home exclusively for their home-based business, there is a deduction available equal to the share of house expenses allocatable to that space, including mortgage interest, insurance, utilities, repairs, and depreciation. But depending on the method used to calculate the deduction, there may be a capital gains tax on the depreciation amount when the house is sold.
Home Improvements for Medical Reasons
Modifications to a home that are prescribed by a doctor and do not increase the value of the home may be tax-deductible. These might include expenses such as wheelchair ramps, stairlifts, widening of doorways and hallways, but would not include the cost of an elevator or lap pool, for example, which would increase the value of the home. These modifications, along with other medical expenses, are deductible as itemized deductions only to the extent that the total exceeds 7.5% of adjusted gross income.
Energy-related Improvements
In recent years, a goal of government policy has been to improve energy efficiency and address climate change, resulting in a variety of tax credits for energy-saving home modifications, especially conversions to renewable sources of energy. The Inflation Reduction Act, passed by Congress in 2022, made some previously available tax credits more generous and added new ones. The myriad of projects that qualify for tax credits and the specific credits that apply to each have given rise to web sites and apps that can help a homeowner decide which improvements to make and when to make them. There are also tax benefits offered by many states.
The Residential Clean Energy Credit was increased from 26% to 30% of the cost. This applies to the installation of solar panels, certain types of solar roofing, solar-powered water heaters (but not for hot tubs and swimming pools!), wind turbines (up to 100 kilowatts of power), geothermal heat pumps, hydrogen fuel cell property (up to $500 for each half-kilowatt of capacity), and battery storage technologies. The installation of an alternative energy charging station is subject to a cap of $1,000.
Another change was the replacement of the lifetime $500 credit for energy-efficient improvements with a $1,200 annual credit using the Energy Efficient Home Improvement credit. This is a 30% credit that applies to (1) the installation of Energy Star-certified items, water heaters, and furnaces, to which there is a $600 annual cap, and (2) other energy-saving improvements, such as adding insulation that meets specific standards or replacing windows (up to $600) and exterior doors (up to $250 per door and $500 per year). There is also a 30% (up to $150) credit towards a home energy audit. Because the maximum $1,200 is applied annually, phasing in these improvements over time can maximize the total credit amount. A separate aggregate annual credit limit of 30% (up to $2,000) applies to the installation of electric or natural gas heat pumps and water heaters and biomass stoves and boilers.
Important Note: These tax credits are not refundable, i.e. they can reduce an existing tax liability to zero but the rest of the credit cannot be taken in cash. However, tax credits can be carried over and applied to future years. Also, there are ways to “create” taxable income against which the credit can be applied, such as by withdrawing money from a Traditional IRA or converting Traditional IRA money to a Roth IRA.
For additional information on Energy Efficient Home Improvement Credit and Residential Clean Energy Credit, visit this IRS link.
As always, if you have any questions about Tax Breaks for Homeowners, please reach us any time at (833) 888-0534 x2 or info@westbranchcapital.com
You might also like our Keep Your Homeowners Insurance Up to Date article.
The views and information contained in this article and on this website are those of West Branch Capital LLC and are provided for general information. The information herein should not serve as the sole determining factor for making legal, tax, or investment decisions. All information is obtained from sources believed to be reliable, but West Branch Capital LLC does not guarantee its reliability. West Branch Capital LLC is not an attorney, accountant or actuary and does not provide legal, tax, accounting or actuarial advice.
About The Author
Anne Christopulos
Anne is a Managing Director and Financial Planner with over twenty years of experience in the financial services industry. After holding corporate management positions in finance and strategic planning in New York City, she moved to Boston to become the Product Manager for the IRA business at Fidelity Investments. Following that, she was Vice President, Retirement Investments, at Fleet Financial Services. A native of Cape Cod, she returned to the Cape in 2001 and made the transition to personal financial planning with Secure Future Financial Services in Dennis and Davis Financial Services in Orleans before joining West Branch Capital. Anne holds a B.A. in music and economics from Wellesley College and an MBA from Harvard Business School.
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