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Complete Guide to First-time Homebuyer Tax Credit & Deductions

March 12, 2021 | Claire Tak

Taxes can be daunting for first-time homeowners. This guide breaks down what you need to know.

  • Tax Day is Monday, May 17, 2021. The IRS extended the deadline from April 15.
  • The standard deduction for 2020 increased to $12,400 for single filers and $24,800 for married couples filing jointly.  
  • The IRS is strongly urging filers to avoid filing through paper-filed tax returns, as it may take even longer to get a return this year. Consider filing electronically. 

In 2020, the world faced a pandemic while the housing market continued to thrive. Certain tax rules have changed, both related to your home and in general, so make sure you understand how these apply to you before you file. You have an extra month to file this year, as the IRS extended the tax deadline from April 15 to May 17, but it’s still a good idea to get them done early.

New homeowners and homebuyers should figure out what they need to pay and how they can save money on their taxes this year. 

Here are tax season tips to understand as a first-time homeowner. 

Down payment for first-time homebuyers

If you’re thinking about purchasing a new home, you could use funds from your IRA or 401(k) to use as part of the down payment. Those with a traditional IRA can withdraw up to $10,000 to buy, build, or rebuild a first home and avoid paying the 10% early-withdrawal penalty. Even though you don’t pay the penalty, you still have to pay taxes on the amount you withdraw. 

With a Roth IRA, you can take contributions at any time without having to pay a tax or penalty. This is because the IRS has already deducted taxes. You can withdraw up to $10,000 in earnings before age 59 ½ to buy your first house without paying the 10% penalty for early withdrawals. 

For a 401(k), you can borrow up to $50,000 without having to pay taxes or penalties. This amount must be repaid within five years. If you lose your job or quit, you’ll have to repay the loan before your next tax return is due. 

PMI Deductions

Private mortgage insurance is added to your monthly mortgage if you put down less than 20% when you buy a home. 

The deduction is phased out if your adjusted gross income exceeds $100,000 and disappears if this number goes over $109,000. Source

Mortgage deductions

A big tax break from homeownership comes from deducting mortgage interest. For taxpayers who itemize, you can deduct interest on up to $750,000 of debt, or $375,000 if married filing separately.

The amount of debt that is deducted should be funds that were used to buy, build, or drastically improve (this does not include basic repairs or maintenance) your primary home or a single second home. 

Property tax deduction

Your local real estate property taxes vary depending on where you live, but you may be able to deduct the state and property taxes you pay on your federal income tax return. 

The caveat here is that you must itemize your taxes in order to be able to deduct the real property taxes. The limit is $10,000 ($5,000 if you’re married but filing separately). Source

Green and energy efficiency in your home for tax credit

You may be eligible to earn a tax credit if you install specific energy-efficient appliances and equipment in your home. Potentially save up to 30% by switching over to greener systems that use solar, wind, and geothermal energy to generate electricity, heat your water, or control the temperature in your house. 

You can also receive a $500 credit on your tax bill by strengthening the insulation in your home by installing energy-efficient insulation, doors, roofing, wood stoves, or water heaters. For energy-efficient windows, you may be able to receive a credit of up to $200. Source

Modifying your home for medical reasons

Installing special equipment or making necessary changes to your home due to medical reasons may also qualify you for a tax break. These home improvements may include adding ramps, installing handrails, widening doorways, installing elevators, changing door knobs, or moving electrical outlets. 

Keep in mind that improvements you make to your home to accommodate an elderly loved one aren’t eligible if they are not medically necessary. 

You can deduct any expenses related to these costs above 7.5% of your adjusted gross income. So, if your income was $100,000 you could deduct expenses that cost more than $7,500 in 2020. You must itemize your deductions. Source

Renting out a room

If you rent out a portion of your home, such as a room or finished basement, you could potential deduct expenses related to:

  • Insurance
  • Repairs and costs to maintain the space
  • Furniture or equipment
  • Real estate taxes

Similar to how you’d do it if you owned your own business and worked from home, you could divide the expense by figuring out the square footage of the space. So, if the room you rent out is 150 square feet and your entire home is 1,500 square feet, you’d deduct 10% of it. Source

Capital Gains when selling your home

If you plan on selling your home in the near future, be aware of capital gains. There are rules and requirements for paying or avoiding this tax. 

If you are married and file a joint tax return, you won’t have to pay taxes on up to $500,000 or $250,000 for single filers from the profit you’ve received in the sale of your home, as long as you meet the following requirements:

  1. You’ve lived in the home for at least two years.
  2. You’ve owned the home for at least two of the last five years. 
  3. You haven’t used this capital gains exclusion in the last two years.

Other tax changes related to the pandemic to be aware of

Recovery Rebate Credit

In 2020, some taxpayers received two stimulus checks. If you were eligible but did not receive a check or believe you qualify for more than what you received, you can claim a Recovery Rebate Credit. You could also qualify if your income decreased last year due to job loss or other circumstances. 

Unemployment benefits are taxed

If you qualified for the extra $600 weekly CARES Act benefits in 2020, you should have received a Form 1099-G. The form shows what you were paid and if any federal income taxes were withheld. 

Check your state’s unemployment website if you have not received one. 

Basically, you need to pay income taxes on this money you received while you were out of work. 

Charitable deductions

Due to the CARES Act, if you donated or gave to charitable causes in 2020, you could deduct up to 100% of your adjusted gross income (AGI, which is your total income minus your deductions) as long as you itemize. 

The CARES Act allows you to write off up to $300 of charitable deductions you made in cash. This means that even if you don’t itemize your deductions, you can still take the $300 in charitable deductions. Just make sure you have receipts and credit card statements to back them up. Source

Retirement changes

There were a number of changes to retirement plans made last year, which could impact your taxes this year.

Here are some notable changes:

  • The CARES Act allows people under the age of 59 ½ to take up to $100,000 out of their 401(k) and IRA until the end of 2020 without having to pay an early withdrawal penalty. If you took money out of your 401(k) you have three years to pay it off and get a refund for any taxes you paid on it. Source
  • If you have a traditional IRA, it’s required that you take money out of your account when you hit a certain age. The SECURE Act pushed back required minimum distributions (RMDs) for traditional IRAs from age 70 ½ to 72. The CARES Act also allows seniors to choose to not take RMDs in 2020. This could mean significant savings since the funds taken out of a traditional IRA counts as taxable income. 
  • In 2020, the SECURE Act allows account holders who have a traditional IRA to continue adding money into their funds past the age of 70 ½ . This money is tax deductible, you could lower your taxable income. When you withdraw the money, however, you will need to pay taxes on it. Source

Don’t forget to use the Where’s My Refund tool

The deadline to file is quickly approaching, so don’t wait until the last minute. The pandemic has prompted specific changes that make filing a return critical, even if you won’t receive a large refund.

If you’re expecting a refund, visit the Where’s My Refund? section on the IRS website to check the status of your refund or tax credit. Most refunds are sent within 21 days of e-filing. 

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