One of the financial advantages of owning a home is that you receive a number of tax deductions that you can use to adjust your gross income and reduce the amount of income tax you pay to the IRS.
The main tax deduction is the Home Mortgage Interest Tax Deduction.
Home Mortgage Interest Deduction
Under 26 U.S.C 163(h) of the IRS Code you can deduct home mortgage interest if you itemize your deductions, the loan is used to secure a primary or second home and up to a limit of $1,000,000 of debt used to acquire, construct or improve the home ($500,000 for single filers) or $100,000 of home equity debt.
If you purchase your home using a mortgage loan your lender will require repayment of the loan over a period of time, usually 25 or 30 years.
During the repayment period your payments will be split into repaying the principal and the interest on the loan. This is known as an amortized loan as it creates a repayment schedule for both the principal and the interest designed to pay off the loan over a defined period of time.
As a general rule the interest portion of your loan repayments is tax deductible.
To calculate how much interest you paid over a year take a look at your mortgage loan account statement. Your lender is required to itemize how your payments are used to pay principal, interest, fees and escrow. Even better, at the end of each financial year your lender is required to send you a document called a 1098 that tells you exactly how much you paid in interest and costs for that year.
As always there are a number of limitations, exclusions and exceptions:
You Must Own Your Home
If you rent your home you are not entitled to deduct your rent payments from your gross income.
This is the primary reason why homeownership is touted as a much better investment than renting a home.
The Home Must Be In Your Name
What if you purchased your home using a Trust, a Roth IRA or a corporate entity like a LLC or Partnership? What if you’re paying off someone else’s loan?
For that vast majority of homeowners this requirement will not be an issue. But it does have serious financial implications for investors and financial planning.
It must be your Primary Residence or a Second Home
What about an investment rental, timeshare or fractional ownership?
You loan must be secured by your primary residence or second home
What if you used an unsecured bank over draft, a personal loan from your parents or you gave your lender security other than the home?