Whether you are buying your first, second, or third home, you need to think about the tax consequences. First time home buyer taxes may catch you off guard. So, it’s better to have a professional guide you through the process and explain to you all the property tax deductions.
Will you be eligible for a mortgage interest deduction? By how much? What about property taxes in the first year? What about the succeeding years?
These are just some questions you may have at the back of your mind. But when you’re buying a new home, you may get too hooked on the process and forget about finding the replies.
Here are reasons you may want to seek expert advice on first time home buyer taxes.
Reason #1: You want to understand firs time home buyer taxes and how owning real estate impacts your property tax deductions
Real estate tax refers to the tax imposed by the local government to the owner of the property. Real estate taxes are usually a certain percentage based on the assessed value of the property. The local government determines the assessed value based on market prices.
Depending on your state, you may also be eligible for exemptions. In New York City, for instance, there is a STAR exemption which may decrease your property taxes. Aside from exemptions, you may also be eligible for abatements.
When buying a property, real estate taxes are usually pro-rated. Most sale contracts stipulate that the seller is liable for real estate taxes up to the day before the closing date. The buyer has to pay the real estate from the closing date onwards. This split is the most equitable and convenient way to split property taxes for the buyer and seller. Plus, the IRS allows property tax deductions based on this method.
If you itemize on your tax return, you may deduct the real estate taxes you paid on the property you bought from the date of closing to the end of the year. These dates should be included in the settlement statement given to you on the closing date. This rule on splitting real estate taxes the buyer and seller can claim applies regardless of who paid the property tax.
What if only one party paid for the real estate tax for the entire year?
In case the seller paid the real estate tax for the whole year, the buyer may reimburse the seller. If the seller did not pay any tax yet, the buyer may charge the seller for his or her prorated share in real estate tax.
While splitting the tax seems straightforward in the first year, you may have concerns about the succeeding years. Unless the local government reassessed the property, you can expect to pay the same real estate tax as the seller for upcoming years.
Your tax advisor may help you understand how real estate taxes work in your state. If you have rented all your life, you may not be familiar with the process. First time home buyers should focus on tax credits, abatements, and other exemptions which may reduce the tax bill.
Pro Tip: Real estate taxes vary across localities. Check your city and/or state website to learn how to compute your property tax bill. The NYC Department of Finance, for instance, has a helpful guide on how to compute annual property taxes in the city. There are usually similar guides in other localities.
Reason #2: You want to minimize transfer taxes
Aside from the property tax, you may encounter other taxes when you buy a new home. These taxes may include the following.
When you buy a property, you may be liable for real estate transfer taxes. Municipal authorities, your county or state may impose this tax when you transfer the ownership of titles, certificates of deeds from the buyer to the seller. This tax is based on the assessed value of the property that has to be transferred.
Usually, sellers will pay the transfer tax as part of the closing expense, but everything is always negotiable. For instance, the buyer may agree to shoulder a portion of the cost.
In some places like Washington, DC, it’s customary for the buyer and the seller to split the transfer tax expense. Although the transfer tax is not deductible, it can be part of the cost basis of the property.
First Time Home Buyer Taxes May Be Different From Regular Transfer Taxes
The rules surrounding transfer taxes also vary per state. In Maryland, for example, first time home buyers are exempt from paying the transfer tax if the property will serve as their primary residence. The seller can 0.25% of the actual selling price. There could be similar programs in the area where you are buying a new home.
Some States Have No Transfer Taxes
You don’t have to worry about transfer taxes if you live Idaho, Indiana, Louisiana, Mississippi, Missouri, and Montana, North Dakota, New Mexico, Utah, Texas, Wyoming, and Alaska. Unless you live in Washington County where there is a 0.1% transfer tax, you don’t have to pay any transfer tax in Oregon.
Aside from those states, people who live in Arizona only have to pay the minimal transfer fee of $2.
Other States May Have Complicated Transfer Taxes
Some states like New York has a more complicated transfer tax computation especially when you live in New York City.
In New York, there is a state transfer tax of 0.4% for properties below $2M. Above this threshold, the tax becomes 0.65%.
If you live in New York City, transfer tax is 1% for residential properties sold at $500K and under and the tax rate increases to 1.425% above this $500K. But that’s not all!
Buyers in New York City also have to watch out for the Mansion Tax which kicks in when the property is sold for more than $1M. You need to pay 1% of the sales price as mansion tax if your property is $1M to less than $2M. This tax has incremental increases and can be up to 4.15% for properties valued at $25M and up.
Depending on your situation, it may be useful to negotiate for a lower price before the higher tax bracket kicks in. Your tax advisor may also privy to some programs or strategies to help you reduce transfer taxes. Having an advisor to help you with transfer taxes could be particularly helpful for first time home buyers without an agent.
Reason #3: You want to know if it’s better to take the standard or the itemized deduction
The Tax Cuts and Jobs Act of 2017 made several changes in the tax law. Standard deduction increased to $12.2K for single filers and $24.4K for joint filers. With this increase, it’s not surprising why most taxpayers opt for the standard deduction.
If you always took the standard deduction, it may be useful to consult an expert if itemizing can have more benefits. A new property could change how you file taxes because you can deduct mortgage interest. You can also take a deduction for property taxes.
Here’s how much property deductions you can take if you decide to itemize.
Mortgage Interest Deduction
The interest you paid for your home is tax deductible but only if you itemize. Before the Tax Cuts and Jobs Act of 2017, you could deduct mortgage interest on the first $1M mortgage. On top of that, you can deduct the interest on $100K home equity debt aka HELOC. You could use the proceeds for this home equity debt for any purpose as long as your home equity serves as collateral.
With the new tax law, you can only deduct mortgage interest on the first $750K of your mortgage ($375K if you’re married and filing separately). As for home equity debt – the interest is only deductible if you the loan for qualified expenses such as home repairs.
State and Local Taxes (SALT)
You can claim the property taxes you paid, your state and local income tax or general sales tax as deductions on your tax return under SALT. But all these taxes have a $10K ceiling.
If applicable, you may also deduct the sales tax you paid for home building materials. This is applicable if you had major repairs done or if you paid sales tax for your home instead of your income tax.
There is generally no sales tax when you buy a home unless it is a mobile home or if it is prefabricated. Depending on what type of home you bought or the state where the property is in, you should consider deducting state and local general sales tax instead of your state and local income tax if you itemize. Your deduction may be higher if you opt for the general sales tax instead of the local income tax especially if there is no income tax in your state.
If you claim the sales tax as a deduction, you cannot include these expenses on the cost basis of your home.
Your tax advisor can help you look into all your expenses and see which option could help you minimize taxes. Plus, you can incorporate all other expenses not just the ones related to owning a property.
Reason #4: You want to know if you are eligible for a tax credit or for other property tax deductions
Who doesn’t want to pay lower taxes?
Tax credits and property tax deductions which can be applied against your tax bill is another thing your tax advisor may help you with. First time home buyers from low-income households may be eligible for the Mortgage Credit Certificate or MCC. The MCC is a program which provides homebuyer assistance to low-income families and allows homebuyers to claim a tax credit for up to $2K per year. You need to be a first time home buyer and meet the income requirements to be eligible.
Your local Housing Finance Agency usually administers the program. So, you need to contact the agency before you apply for a mortgage and buy your home. You can claim this tax credit on your annual tax return.
There is also another type of tax credit which is applicable to energy-efficient homes.
If you have energy-efficient features in your home, you may be eligible for a Residential Energy Credit. You can claim credits of up to 30% of the installation cost for solar, wind and geothermal equipment on your principal residence. There are more limitations for fuel cell property which is $500 for half-kilowatt of the property’s capacity.
There may be more tax credits and a tax advisor familiar with your state laws will have a better idea on all of these tax breaks.
Reason #5: Your new home is in a new state
If your primary residence changed because of your new home, your local taxes may also change. Take note that your local and state income tax is also subject to the $10K SALT limit.
Most states impose a separate income tax. But there are still a few states where you don’t pay this tax including Florida, Nevada, Alaska, Texas, South Dakota, Washington, and Wyoming. New Hampshire and Tennessee do not impose a personal income tax, but interest and dividends are subject to tax.
If you are moving another state, you may have to file taxes on both states. If you live and work on different states, tax issues may also be different.
While you can claim a tax credit on taxes paid in one state to another, you may want to make a checklist on what you need to do to make tax filing less complicated. The best person to ask about this will be your tax advisor!
Don’t Let First Time Home Buyer Taxes Scare You. Take Advantage Of Your Property Tax Deductions
Buying a home is a major expense but you don’t have to focus only on it. Having a tax advisor can help you look at the bigger picture and manage the rest of your finances.
A property under your name will affect your tax return from the day it becomes yours. Knowing what the tax consequences are is always a must. Sitting down with an expert to discuss these matters may save you from regrets later on.
If you are on the US on a temporary visa such as H-1B, you are a non-citizen who may return to his or her home country, you want to give the property as a gift or you have a complex tax situation, tax planning could become even more valuable.
Your tax advisor would most likely suggest changes on your finances depending on your goals. Making adjustments on your retirement contributions, taking advantage of legitimate deductions, putting funds on tax-advantaged accounts and similar strategies may help offset the cost of your new home.
While you don’t need a tax advisor just because you’re a first time home buyer having one can help you to:
- Minimize taxes for the property you want to buy through federal and state programs and tax credits
- Maximize tax deductions and tax credits for all applicable taxes including property tax
- Create a plan to help you take advantage of your deductions and reduce your tax bill legally in succeeding years
Dealing With First Time Home Buyer Taxes: Putting it All Together
First time home buyers should allocate time to talk to a tax advisor to discuss issues such as:
- How do real estate taxes work in your state? What deductions, exemptions or abatements can you take?
- How do income taxes work in your new address? Are there things you have to take note of?
- Is there a way to minimize the taxes you have to pay when buying your new home?
- Should you itemize or take the standard deduction?
- What can you do to offset the cost of buying a new home?
- Are there any changes you have to do to reduce your tax bill for the year? How about the succeeding years?
Tax planning is a highly personal process which depends on your wants, needs, immediate and long term goals. Consulting an expert, about first time home buyer taxes and other concerns can help you find the best strategy based on your financial situation.