Becoming a homeowner is a huge milestone and is very exciting. However, it is also a big responsibility and part of that is a tax responsibility.
Tax isn’t all bad, it can work for you in some instances. Understanding the ins and outs of real estate tax laws is crucial for homeowners to maximize their financial benefits and avoid potential pitfalls.
Here are the essential aspects of real estate tax laws that all real estate owners should be aware of.
Property Taxes
What are Property Taxes?
Property taxes are levied by local governments based on the assessed value of your property. Your property includes both the land and any structures on it.
These taxes generally go towards funding public services such as schools, roads, and emergency services. The rate you pay can vary significantly depending on where you live.
Assessment and Appeals
Your property’s assessed value will be determined by local assessors, but these can be appealed if you don’t agree with the assessment (particularly if you believe the assessment is too high).
It’s important to understand how the assessment process in your area works and keep track of assessment notices. If you disagree with an assessment, most jurisdictions have an appeals process you can follow.
Federal Tax Deductions
Mortgage Interest Deduction
This is one of the biggest tax benefits for homeowners. The mortgage interest deduction allows you to deduct the interest paid on your mortgage from your taxable income. This can result in substantial savings.
This deduction applies to mortgages on your primary residence and, in some cases, a second home, up to a certain limit.
Property Tax Deduction
Another thing that homeowners can deduct from their federal taxable income is the amount paid in property taxes.
This deduction, along with the mortgage interest deduction explained above, can significantly reduce the overall amount of tax you have to pay.
It is however important to note that there is a cap in the deduction for state and local taxes (including property taxes) of $10,000 in terms of the Tax Cuts and Jobs Act of 2017.
Capital Gains Tax
Exclusion of Capital Gains
When you sell your primary residence, you may be able to exclude up to $250,000 of capital gains from your taxable income. This is applicable per person when filing jointly, so a married couple can exclude up to $500 000 for example.
To qualify for the exclusion, you must have owned and lived in the home for at least two of the five years before the sale. This exclusion can help you pay substantially less tax when you sell your home at a profit.
Reporting Gains and Losses
If your capital gains exceed the exclusion limits, or if you sell a second home or investment property, those gains are subject to capital gains tax. It’s essential to report these correctly on your tax return. Conversely, if you sell your home at a loss, you generally cannot deduct the loss.
Tax Benefits of Home Improvements
Home Improvement Deductions
While home improvements are not generally deductible, they can increase your home’s basis, which reduces your capital gains when you sell it.
For your basis to increase, improvements must do at least one of the following things:
- add value to the home
- prolong its useful life
- adapt it to new uses
Make sure you keep thorough records of all improvement expenses to adjust your basis accurately.
Energy-Efficient Home Credits
You can also get federal tax credits for certain improvements that increase your home’s energy efficiency. Things such as installing solar panels, energy-efficient windows, or heating and cooling systems can count towards these credits.
These credits directly reduce your tax bill and are there to encourage homeowners to make environmentally friendly upgrades.
Tax Implications of Rental Income
Reporting Rental Income
If you rent out part of your home or a separate property, you must report the rental income on your tax return. This includes things like advance rent, security deposits used as rent, and any other payments received from tenants.
Deductions for Rental Properties
Rental property owners can also deduct expenses related to the property, including mortgage interest, property taxes, operating expenses, depreciation, and repairs. These deductions can offset rental income and reduce your taxable income.
Special Considerations
Home Office Deduction
If you use part of your home exclusively for business purposes, you may qualify for the home office deduction.
This can include a portion of your mortgage interest, property taxes, utilities, repairs, and depreciation. The space must be used regularly and exclusively for business to qualify.
Impact of Moving
Relocating can also have various tax implications. If you move for work, you may be eligible for a deduction of moving expenses, although this is currently limited to active-duty military personnel only under the Tax Cuts and Jobs Act.
Staying Informed
Tax laws are subject to change, and staying informed is crucial for homeowners.
Consulting with a tax professional is a great idea as they can help you navigate complex tax situations and ensure compliance with current laws. Additionally, tools like cost segregation studies, which RE Cost Seg specializes in, can identify tax savings opportunities for property owners by reclassifying assets for faster depreciation.
Understanding these aspects of real estate tax laws can help homeowners make informed decisions, optimize their tax situation, and ultimately enhance their financial well-being.
