Purchasing a home is a life-altering, exciting, awful, terrific experience. You gain the freedom that you’ve always dreamed of and then instantly lose it trying to take care of your house. One thing you might not think of is the tax implications of purchasing a home.
There are additional write-offs that may become available with home ownership. Under current tax law, all taxpayers either take the standard deduction or they itemize their deductions. Here’s how that works for those of you who are not accountants:
This is a standard amount that is deducted from your total income to arrive at your taxable income. In 2020, single people get $12,400, and married people get $24,800. People who file head of household status get $18,650.
For most taxpayers, figuring your taxable income is as simple as adding up all of your income (W-2’s, investment income, business income, etc.) and subtracting this standard amount from that figure. You get this deduction for being a living, breathing American. You actually get it the year you die too, but you won’t be thinking much about your taxes at that point.
You will itemize deductions instead of taking the standard deduction if ALL of your itemized deductions total to more than the standard deduction. It is an either/or situation. If you itemize, you report your itemized deductions on schedule A on your tax return. I’ll explain what deductions are available for itemization, and why so few people itemize deductions under the new tax law passed in December of 2017.
In 2020, medical expenses are deductible if your total medical expenses are more than 10% of your adjusted gross income. For example, if you make $100,000 per year and have no other adjustments on your tax return, your medical expenses won’t start becoming deductible until after you’ve hit $10,000 in expenses.
Hearing this can be upsetting when you’re in this income range and you’ve reached your full $6,000 deductible for the year. Regardless, if you do exceed 10% of your adjusted gross income, any expenses after that can be taken as an itemized deduction.
This has been a topic of pretty heavy debate over the last year. This deduction is made up of your state income taxes (usually the amount of state withholding on your W-2) plus your real estate taxes paid on your home. This is where home-ownership can start to change things for some taxpayers.
However, note that this deduction is limited to $10,000 in 2020. So if you own a home and pay $15,000 in real estate taxes, your total state tax deduction is capped at $10,000. This law may change though, as senators in high-tax states such as New York and Connecticut have this at the top of their list.
Assuming you didn’t buy your house for cash, you are currently paying a mortgage to a bank. Part of each payment is allocated to interest, and the total interest you pay to the bank is reported to you on form 1098 at the end of the year. This can be deducted as an itemized deduction.
If you had less than a 20% down payment on your home purchase, chances are you are also paying mortgage insurance with each payment (PMI). This can also be deducted with your mortgage interest each year. However, the deduction starts to phase out once adjusted gross income reaches $100,000, and is completely phased out once your AGI reaches $109,000.
If you donate to any charities throughout the year, keep records of your contributions as you may be able to deduct these as well. These include cash contributions to 501(c)(3) organizations as well as non-cash donations to facilities like Goodwill.
If you contribute to Goodwill or other similar organizations, make sure to get a receipt for each drop-off. On the back of the receipt, write a brief description of what was donated and each item’s estimated value. If you value any individual drop-off over $500, your accountant is probably going to ask you for some more detailed information, such as the original cost of each item.
A note for 2020: Part of the CARES Act allows individuals to take an above-the-line deduction for charitable contributions. This amount is $300 for singles, and $600 for married couples. Keep this in mind when giving your tax documents to your accountant this year.
After totaling up all of your deductions listed above, the majority of Americans come up short of their standard deduction. For tax purposes, it just means you take the standard deduction and move on with your life. It doesn’t necessarily hurt your tax situation, as the current law is pretty generous for most people. The problem is that it disincentivizes individuals to purchase homes or donate to charity.
Sometimes tax laws are written to get people to behave a certain way. Under prior laws, there was more incentive to purchase a home or donate to charity because of the tax write-offs that were available. In other words, the government wanted to encourage this type of behavior. Now that the standard deduction is so high, many people think, “why bother donating if I won’t get a write-off for it?” Of course donating is still a great thing to do, but it’s nice knowing it will save you a bit in tax dollars.
As always, taxes are boring and complicated for most people. If you’d rather slam your head off of a table than read this article again, contact me and I’ll take care of it for you.
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