Tax Tips for First-Time Homebuyers

 photo: sean_dreilinger

Tax breaks are among the incentives that lure renters into buying their first home. Though the $8,000 homebuyer tax credit expired on April 30, 2010, homebuyers can still take advantage of other tax incentives. (Unless you signed a binding contact to purchase a home before April 30, in which case you have until June 30, 2010 to complete that puchase.) Here are several options to consider.

Deducting Mortgage Interest, Points and Property Taxes
The trifecta of tax deductions for homeowners includes mortgage interest, points, and property taxes. This information is listed on your HUD-1, which is the form used by the closing agent to itemize all the funds paid by the buyer and seller. You’ll need to attach this form to your tax return, but should you misplace it in the chaos of move in, your real estate agent or escrow holder can generally send another copy.

Paying points reduces your mortgage interest rate, and each point (also called a loan origination fee, maximum loan charge, discount point, or loan discount) is equal to one percent of the loan amount. “For every point you pay, you are prepaying interest so they would discount the interest based on the points you pay at closing,” explains Tara-Nicholle Nelson, a real estate broker, attorney and consumer educator for Trulia.com. Points are 100% tax deductible in the calendar year in which you close escrow, as long as you meet the list of IRS requirements. One caveat: points paid in a refinance are deducted over the life of the loan, not all at once.

Of course, this assumes that you’re itemizing deductions on your Schedule A, which doesn’t automatically mean you’ll come out on top. “Generally, the rule of thumb [for homeowners] has been to itemize,” says Nelson. Still, some homeowners may end up better off taking the standard deduction — that is, the mortgage interest and other deductible expenses they incurred througout the year may still add up to less than the standard deduction.

Even in those cases, however, itemizing can be advantageous. Ebong Eka, a Virginia-based CPA who specializes in real estate and corporate accounting, says it gives homeowners the ability to add on other itemized deductions. (One possibility is charitable deductions, which can be claimed only by tax payers who itemize.)

Run both sets of numbers to see if you’ll save more money by itemizing or taking the standard deduction (for 2010, that means $8,400 for heads of households, $11,400 for couples filing jointly, and $5,700 for those filing individual tax returns).

Applying for Mortgage Credit Certificate
The Mortgage Credit Certificate (or MCC) is a straight tax credit that does not require you to itemize, but many people don’t know about it, says Mike Winesburg, a wealth advisor and mortgage planner at McKinley Carter Wealth Services.  

The criteria vary by state, but generally you must meet certain income limits and go through a participating lender to quality for MCC. “It’s generally thought of as a first-time homebuyer program but in some states you don’t even have to be a first-time homebuyer,” Winesburg says.

For instance, in West Virginia, where Winesburg practices, “the credit can be for as much as 35% of your annual mortgage interest expense. And the remaining 65% of interest is still eligible for the more commonly known mortgage interest deduction.”

Regardless of where you live, the IRS caps MCC at $2,000 a year, but you can continue receiving the credit as long as you retain the mortgage and live in the home as your primary residence.

The MCC is separate from the recently-expired home buyer tax credit and it means greater savings than simply deducting mortgage interest. “Any tax credit is better than taking a deduction if you quality for it,” says Eka. “The credit is dollar for dollar, so if I owe $1,000 in taxes and I have a $100 tax credit, I will only pay $900.”

Adjusting Payroll Withholding
You don’t need to wait until tax time to see the savings associated with home ownership, Nelson says. “I’m constantly talking to people about how to change their payroll tax withholdings to account for the new deductions so they can bring more cash home to help pay their housing costs,” she says.

The IRS’ online withholding calculator can help you determine how much you need to adjust.

Whatever tax deductions you’re taking or improvements you’re making to your new home, it’s important to keep all your records, even if those improvements won’t factor into capital gains for years to come (once you sell your home, $250,000 of your profit for a single tax payer or $500,000 for a married couple will be exempt from capital gains tax).

“Always keep receipts for improvements,” says Eka. “Keep track of all your receipts and make sure you can substantiate any deductions, which will help mitigate if somebody questions or if you end up being audited.” That will also make it easier to prepare your return and budget for the future.

Susan Johnston is a Boston-based freelance writer who covers business and lifestyle topics.