Tax Credits and Deductions for First-Time Homebuyers

Highlights:

• A tax credit is a dollar-for-dollar amount that taxpayers may claim on their tax return to reduce what they owe when they file their taxes. A tax deduction subtracts a certain amount from your taxable income.
• First-time homebuyers may be eligible for certain tax breaks, including mortgage interest deductions, origination fee deductions and property tax deductions.
• If you’re ready to purchase your first house, remember to look beyond tax benefits for places to save. First-time homebuyers may be eligible for public and private assistance in the form of special loans, grants and other programs.

If you’re a first-time homebuyer, tax credits and deductions can significantly reduce the cost of your first mortgage when tax season rolls around. Here’s what first-time homebuyers should know about home buying-related tax credits and deductions to make the most of their purchase.

Who qualifies as a first-time homebuyer?

You generally qualify as a first-time homebuyer if you have never bought a primary residence. Even if you’ve previously owned a residential property, you may still be considered a first-time buyer if you’ve lived in a home for less than three years but had no ownership of the property during that time. You may also be eligible in select other circumstances, including:

• If you are a single parent who previously only owned a home with a former spouse
• If you have previously only owned a mobile home, manufactured home or other residence unfixed to a permanent foundation
• If you have only owned property that was not up to building codes and could not be brought to code for less than the cost of buying a new permanent structure.

Tax credits for first-time homebuyers

A tax credit is a dollar-for-dollar amount that taxpayers may claim on their tax return to reduce what they owe when they file their taxes. For example, if you owe $1,500 on your federal tax return but qualify for a $1,000 tax credit, the amount you owe drops to $500.

The primary tax credit available to first-time homebuyers is the mortgage credit certificate (MCC). This federal tax credit allows you to deduct a portion of your mortgage interest each tax year. MCCs are limited to low- and moderate-income homeowners. To qualify, you’ll apply with your lender and, if approved, you’ll be eligible to claim a tax credit of up to $2,000 each tax year. Your refund will be equal to a percentage of the interest you pay on your mortgage each year. Percentages vary by state, but are usually between 20% and 40%.

Tax deductions for first-time homebuyers

First-time homebuyers may also qualify for tax deductions, which work differently from tax credits. Instead of reducing your tax burden dollar for dollar, a tax deduction subtracts an amount from your taxable income.

Many homeowners, including first-time homebuyers, may qualify for several tax deductions to reduce the overall cost of homebuying. These include:

• Mortgage interest deduction. You may be able to deduct interest payments on mortgage balances up to a certain amount. Generally, you can deduct mortgage interest on the first $750,000 of your loan if you’re single or married and filing jointly and $375,000 if you’re married and filing separately. If your home was purchased prior to December 16, 2017, you may be able to deduct mortgage interest on the first $1 million of your loan if single and filing jointly, or $500,000 if married and filing separately.
• Mortgage points deduction. When taking out a mortgage, some homebuyers may purchase optional discount points from their lender. These points reduce a loan’s interest rate in exchange for an up-front fee. Provided homeowners meet certain qualifications outlined by the IRS, they can usually deduct the cost of these discount points as interest when they file their taxes.
• Loan origination fee deduction. Lenders charge loan origination fees to offset the cost of underwriting your mortgage. These fees are generally tax-deductible, even if paid by the seller.
• Property tax deduction. Certain state and local property taxes may be deductible from your federal taxes, up to $10,000 per year. These generally include property taxes for a primary home, vacation home and other property, as well as taxes on qualifying personal property such as cars, RVs and boats.

Other money-saving programs for first-time homebuyers

If you’re ready to purchase your first house, remember to look beyond tax benefits for ways to ease the financial burden. First-time homebuyers may be eligible for public and private assistance in the form of special loans, grants and other programs, including:

• Traditional or Roth IRA penalty waiver. Some first-time homebuyers under the age of 59 1/2 can waive the usual 10% penalty for early IRA distributions if they’re using the money to help fund a qualified first-time home purchase. This generally applies to the first $10,000 of the withdrawal.
• FHA, VA and USDA loans. These mortgages are typically offered to qualifying first-time homebuyers by federal agencies. Because they are partially or entirely backed by the federal government, they may be a lower-cost alternative to conventional loans.
• Housing Choice Voucher (HCV) homeownership program. Those eligible for assistance through the HCV homeownership program, which allows qualifying families to apply their voucher toward a home purchase and receive monthly assistance with home ownership expenses, may also be entitled to aid through the Department of Housing and Urban Development’s homeownership services.
• Down payment assistance programs. State and local public housing agencies may offer special loans or grants to help cover the cost of your down payment. This type of assistance can substantially reduce your out-of-pocket costs.

These government programs and policies, alongside tax deductions and credits, can help turn the dream of homeownership into a reality for first-time buyers. Just remember: the tax code is rewritten and amended regularly. Be sure to research any changes to federal, state and local tax laws before you file your tax return, and check with your tax advisor for specific guidance about your situation.