All homeowners should be aware of these three tax tips well before the day that taxes are due.
Most homeowners will tell you that the biggest advantage to buying a home over renting is the tax deductions. You've probably read again and again that your mortgage payments, a big chunk of your closing costs, and your real estate taxes are deductible. Unfortunately, this is not always true!
Getting a basic understanding of what deductions you qualify for as a homeowner isn't complicated. "It's pretty basic stuff, but HUGE info," says Dan Keller, a Seattle-based mortgage lender who always recommends that his clients consult with a tax professional.
Here are three tidbits about taxes that every homeowner should know.
1) There is a limit to how much mortgage interest you can deduct
While you can deduct mortgage interest from your taxes, most people don't realize that there is a limit to how much mortgage interest you can deduct. The limit for deductions is one million dollars. "If you buy a two million dollar apartment, put down 500,000, and take out a million and a half mortgage, you can't deduct all of it," says Bryan Kohler, a New York City-based tax manager for MBAF ERE. "Mortgage interest is only deductible up to a million dollars and one hundred thousand on a home equity loan. Excess of that is not deductible."
This is especially important information for those who live places like New York City, where the average apartment is a million dollars. "If you buy a three million dollar apartment and take out a mortgage of over a million dollars," says Kohler, "not all of that interest is deductible."
2) Double up on your December mortgage payments and accelerate your deduction
If you would like to accelerate your deductions for a given year, you can double up on some of your mortgage payments. "Individuals are on a cash basis," says Kohler. "So if there is no prepayment penalty and you prepay your January payment in December, effectively you've made thirteen payments in that year."
"There is a little strategy to this concept," says Dan Keller. "You must get your payment to your mortgage lender in plenty of time for them to process the payment prior to January 1. I recommend giving your lender at least ten days!"
Another offshoot of this strategy is that if you make thirteen or more payments per year, you can chop years off of the duration of your mortgage.
3) If you are subject to the alternative minimum taxes you can't deduct your real estate taxes
If you are in the alternative minimum, you do not get a dollar benefit whatsoever for paying your real estate taxes. Many people do not realize that and more and more average people are being subjected to it.
"The alternative minimum tax was put into the system in the 60s to make sure that really wealthy people couldn't come up with crazy deductions to avoid paying taxes," explains Kohler. "What happened is that they never really indexed it for inflation. At this point, instead of just scooping up the upper crust, it's getting more and more into the middle class."
As a taxpayer, you probably know whether or not you are subject to the alternative minimum. However, as a new homeowner, you may not have realized that you are not eligible for a deduction on your real estate taxes.
Exploring your options with the alternative minimum taxes, paying down your mortgage early, and figuring how much mortgage interest you can deduct are all easy to understand in theory, but can be much more complicated in practice. It's worth your while to consult with a tax professional to come up with realistic tax strategies that wont get you audited down the line.