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August 7, 2020
By Laura Saunders
The coronavirus pandemic has had profound effects on real
estate, and the sudden shifts make it a good time to delve into tax breaks
available to home buyers and homeowners.
Many people are scrambling to get mortgages now that
interest rates are under 3%, either to buy a home in a red-hot market or
refinance debt on an existing one. Others, who are working from home far longer
than expected, are itching to renovate their nest or add workspace.
And then there are those who have moved to vacation homes
for the long haul. Some are even social-distancing in motor homes or boats.
The tax landscape for homeowners changed with the 2017 tax
overhaul, which made the long-cherished mortgage-interest deduction irrelevant
for many. For 2018, 13 million filers claimed this write-off, down about 60%
from 2017’s total of 33 million filers. The overhaul also limited interest
deductions on home-equity loans and repealed a benefit for some home offices.
But other tax breaks for homes remain, such as one allowing
mortgage-interest write-offs for motor homes and boats. Loosened rules on
withdrawals from retirement accounts could provide a source of funds for home
buyers who need cash this year. A spokeswoman for TD Bank said it’s allowing
such withdrawals to be used for down payments
Whether you’re part of a backlog of buyers or mulling
changes to your current home, here are answers to key questions—plus examples
to show how the rules apply in different situations.
Will I get a mortgage-interest deduction if I buy a home?
Yes, but it might not lower your taxes, if your “standard
deduction” is higher than your total itemized deductions listed on Schedule A.
The 2017 overhaul nearly doubled the standard deduction, and
now it’s $24,800 for most married couples filing jointly and $12,400 for most
single filers. So millions fewer homeowners are itemizing.
Typical itemized deductions are for mortgage interest,
charitable donations, medical expenses and state and local taxes (SALT), such
as property and income or sales taxes. SALT deductions are limited to $10,000
per tax return.
Here are examples provided by Evan Liddiard, a CPA who
directs federal tax policy at the National Association of Realtors. Say that a
married couple buys a $400,000 home with a 20% down payment, a 3% interest rate
and a 30-year fixed rate mortgage. The first-year interest deduction would be
about $9,500.
If the couple deducts that amount, along with the limit of
$10,000 for SALT, they’d still need more than $5,300 in charitable or other
write-offs to get above the $24,800 threshold.
Many single filers will find it easier to get a benefit. If
a single person buys a $250,000 home with 20% down and a 3% interest rate, the
first-year interest is about $5,950. If this buyer lives in a higher-tax area
and has $10,000 of SALT write-offs, then his total itemized deductions are more
than $3,500 above the $12,400 threshold, even without other write-offs.
How much mortgage interest can I deduct?
For new mortgages issued after Dec. 15, 2017, taxpayers can
deduct interest on up to $750,000 of mortgage debt on up to two homes.
For mortgages issued before that date, a “grandfather”
provision allows interest deductions on up to $1 million of mortgage debt on up
to two homes.
Here’s how these two rules can interact. If a homeowner has
a grandfathered $800,000 mortgage on a first home and wants to borrow $100,000
to buy a second home in 2020, then the interest on the $100,000 wouldn’t be
deductible. For more information, see IRS Publication 936.
Note that the $750,000 limit applies per tax return, so
unmarried couples who buy homes together can deduct interest on up to $1.5
million of mortgage debt. Some couples in high-cost housing markets have
refrained from marrying in order to double their deduction.
I’m refinancing my mortgage at a lower rate. Can I still
deduct the interest?
Yes, in many cases. But current law disallows deductions on
the “cash-out” portion of a refinancing unless it’s used to improve a home.
Say that a borrower with a $400,000 mortgage balance
refinances at a lower interest rate but raises the balance to $450,000 in order
to have $50,000 for college tuition. In that case, only the interest on
$400,000 would be deductible. But if she uses the $50,000 to add a room, then
interest on the $50,000 would be deductible, says Mr. Liddiard.
Are “points” paid to get a mortgage deductible?
Yes. Points are upfront interest payments that typically
reduce the rate. Points paid for a first mortgage are usually deductible the
year it’s taken out, while points paid on a refinancing typically must be
deducted over the loan’s term.
I want to borrow to buy a boat or RV. Can I count that as a
home and deduct mortgage interest?
Maybe! Mortgage interest on debt used to buy a motor home or
boat can be deductible if it has cooking, sleeping and toilet facilities. The
write-off is also subject to the other requirements, such as no deductions for
more than two homes.
Mortgage interest on these homes may not be deductible for
the alternative minimum tax—but far fewer people owe this levy than before the
2017 overhaul.
Can I still deduct interest on a home-equity loan?
It depends. Until the 2017 overhaul, interest on up to
$100,000 of home-equity debt used for any purpose was deductible.
Now, such interest is deductible if it’s used to make
substantial improvements to a home. The debt must be secured by the property
it’s used for, and the $750,000 and $1 million total debt limits apply.
Now that I’m working from home, can I take a home-office
deduction?
Not if you are an employee, because the 2017 overhaul
repealed that write-off. But your company can likely reimburse you for your
work expenses during the pandemic and get a deduction. The payment won’t be
taxable to you, says Gerard Schreiber, a CPA who specializes in tax issues
involving disasters.
Workers who are self-employed, either full-time or
part-time, can often deduct home-office expenses on Schedule C for a space
that’s used regularly and exclusively for the business. (That means no watching
sports on a couch in the office during off-hours.) For more information, see
IRS Publication 587.
I’m spending more time at home, and I want to remodel my
house and add office space. Are there tax breaks for remodeling?
Yes, in some cases. A business owner who builds or upgrades
office space at home may be able to take deductions for costs. For example, a
photographer’s expenses for adding a studio and darkroom to her home could be
deductible over time on Schedule C, as could the interest on a borrowing to finance
it.
For homeowners without businesses, the cost of improvements
such as an addition can raise the “cost-basis” of the house and reduce taxable
profit when it’s sold. So if a house was bought for $250,000 and the owner made
$150,000 of improvements, then the starting point for measuring the gain after
a sale would be $400,000. The interest on a home-improvement loan can also be
deductible.
This year many people can withdraw more from such savings
plans than in the past, and on better terms, because Congress loosened rules
for people affected by the pandemic. These savers can withdraw up to $100,000
from IRAs and many 401(k)s without owing the 10% penalty that would often
apply. Then they can spread the tax over three years or pay all or part of the
withdrawal back, according to IRA specialist Ed Slott.
I have a city home and a vacation home, and until the
pandemic I lived in the city. If I make my vacation home my primary residence,
can I avoid owing city taxes?
Maybe—but rules vary widely, so seek professional advice
tailored to your area. For example, people with jobs based in New York often
owe taxes to New York even if they’re residents of other states.
To switch your vacation home to your primary home, you may
need to count days spent in each place. You may also need to make moves showing
you’ve truly changed your residence, such as switching doctors, children’s
schools, your place of worship, and where you vote.
Write to Laura Saunders at laura.saunders@wsj.com
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