How Buying a Home Can Have Legal & Financial Benefits
If you are deciding whether to buy a home or continue renting, you may face doubts about whether undertaking such a significant expense makes sense for you. Buying a home clearly has a short-term and a long-term impact on many aspects of your life, and you should not make this decision lightly. However, in addition to no longer needing to deal with a landlord, there are certain benefits to buying a home of which you should be aware.
Home Buying Pros and Cons
Qualify for tax deductions and credits
Risk the property losing value
Incur extra expenses, such as property taxes, home maintenance and repair costs, and insurance
Pay mortgage interest on top of the principal
Risk a difficult and expensive sale
A home is an asset that is likely to appreciate in value over time, and you have the opportunity to gain control over it by spending a modest amount of cash in your down payment. The value of the house may rise as the balance of the principal on your mortgage falls. This allows a homeowner to build equity, which is the difference between the value of the home and the loans taken against it. By contrast, when you are renting, each payment may seem cheap but is cash that you simply lose rather than use to build an investment.
Successfully paying down a mortgage helps homeowners build credit, and an improved credit rating can make a difference in many areas of life. If you are looking to start a business, having a history of meeting your mortgage payments may make it easier to get the loan that you need at the outset. Or perhaps your child is heading to college, in which case you may need a student loan to help cover the cost. In this situation as well, having shown that you handled the mortgage successfully will boost your chances of getting this type of loan.
These consist of both tax deductions and tax credits. While tax deductions are subtracted from your gross income earned throughout the year to reduce the amount of your income that can be taxed, tax credits are reductions in your tax liability by a certain amount. People who are buying their first home sometimes receive tax credits. Although no federal tax credit for first-time home buyers is currently available as of mid-2022, buyers may be eligible for similar state programs. If you make various home improvements that improve energy efficiency, or if you install certain systems to generate electricity, you also may be eligible for a tax credit. This can be claimed through IRS Form 5695.
The Mortgage Interest Credit
Lower-income individuals may be eligible to claim the mortgage interest credit each year for a portion of their home mortgage interest payments. Qualifying individuals must receive a mortgage credit certificate (MCC) from a state or local government agency before buying a home. They can then attach the MCC to Form 1040, 1040-SR, or 1040-NR and complete Form 8396 to claim the credit.
Meanwhile, you can get a tax deduction for the interest on your home mortgage, assuming that it is not beyond a certain amount. State property taxes, which consist of about one percent of the home’s value, are paid on an annual basis and may be deducted from your federal taxes. You can also deduct the interest on a loan to make home improvements (but not the interest on a loan to make repairs). Other types of expenses that may be deductible include interest on a home equity loan and expenses for a home office if you run a business from your home. You also may be able to get deductions related to home mortgage points, which are fees attached to getting a reduced interest rate on your mortgage.
To get any of these types of deductions, you will need to carefully itemize your deductions. You should check to make sure that your itemized deductions exceed the standard deduction. If not, you should continue using the standard deduction.
In the event that you sell your home, you will be eligible for a reduction in the capital gains tax in most situations. Generally, the seller must have lived in the home for two of the previous five years before selling it. Getting this reduction can allow you to upgrade to a bigger, more expensive home more easily.