How to Handle Real Estate Taxes and Deductions

Navigating Real Estate Taxes and Deductions: A Guide for Property Owners

Real estate taxes and deductions can be tricky for property owners. Understanding how they work can save you money and help you maximize your investments. Let's dive into the essential aspects of real estate taxes and deductions that every property owner should know.

Understanding Real Estate Taxes

What Are Real Estate Taxes?

Real estate taxes are levied by local governments on properties, including homes, land, and commercial buildings. These taxes help fund public services such as schools, roads, and emergency services.

How Are Real Estate Taxes Calculated?

Real estate taxes are typically based on the assessed value of your property. Local tax assessors determine this value, often a percentage of your property's market value. Each jurisdiction has its own tax rate, known as the millage rate, which is applied to the assessed value to calculate the tax amount.

Paying Real Estate Taxes

Real estate taxes are usually paid annually, semi-annually, or quarterly, depending on your local jurisdiction. Some mortgage lenders include tax payments in your monthly mortgage payment, holding the funds in an escrow account until the taxes are due.

Deducting Real Estate Taxes

What Are Property Tax Deductions?

The IRS allows property owners to deduct real estate taxes on their federal tax returns. This deduction is an itemized deduction, meaning you need to list all eligible deductions on Schedule A of your 1040 tax form. Deductions can reduce your taxable income, potentially lowering your overall tax bill.

Who Qualifies for Real Estate Tax Deductions?

Most property owners who itemize their deductions can claim real estate tax deductions. However, there are some limitations and exceptions. For instance, under current tax laws, your total state and local tax deduction, including property taxes, is capped at $10,000 per year ($5,000 if married filing separately).

Understanding Mortgage Interest Deductions

What Is the Mortgage Interest Deduction?

The mortgage interest deduction allows homeowners to deduct interest paid on their mortgage. You can claim this deduction when you file your federal income tax return, potentially lowering your taxable income.

Who Can Claim the Mortgage Interest Deduction?

To qualify for the mortgage interest deduction, you must itemize deductions on your tax return. Only interest on loans secured by your main or second home is eligible. Additionally, the loan must be used to buy, build, or substantially improve the property.

Limits on the Mortgage Interest Deduction

Under current tax laws, you can only deduct interest on the first $750,000 of mortgage debt ($375,000 if married filing separately) for loans taken out after December 15, 2017. For mortgages taken out before this date, the limit is $1 million ($500,000 if married filing separately).

Expensing Rental Properties

Depreciation of Rental Properties

If you own a rental property, the IRS allows you to depreciate it over time. Depreciation is an accounting method that lets you deduct a portion of your property's cost every year. The standard depreciation period for residential rental property is 27.5 years.

What Can Be Depreciated?

The cost of the building itself can be depreciated, but not the land. You can also depreciate improvements made to the property, such as a new roof or HVAC system. However, regular maintenance and repairs are typically deducted in the year they occur rather than depreciated.

Other Valuable Tax Deductions for Property Owners

Home Office Deduction

If you use part of your home exclusively for business purposes, you may qualify for a home office deduction. This deduction allows you to write off expenses related to the portion of your home used for business, such as utilities and repairs.

Energy-Efficiency Credits

Tax credits are available for homeowners who make energy-efficient upgrades. These credits can be claimed for installing solar panels, energy-efficient windows, and other qualifying upgrades. Unlike deductions, which reduce taxable income, tax credits directly reduce the amount of tax owed.

Points Deduction

When you take out a mortgage, you may have the option to pay points to reduce your interest rate. Each point costs 1% of the loan amount. These points are deductible in the year you pay them if the loan is for your primary residence.

Common Mistakes to Avoid

Overlooking Itemized Deductions

Many filers opt for the standard deduction because it's simpler. However, if your itemized deductions exceed the standard deduction, it's worth the extra effort to itemize.

Forgetting to File for Homestead Exemption

Many states offer a homestead exemption, which can reduce your property's assessed value and, in turn, lower your real estate taxes. Make sure to apply for this exemption if you qualify, as it's not automatic in most areas.

Misunderstanding Sale of Home Exclusions

When selling your home, you might qualify for a capital gains exclusion: $250,000 for single filers and $500,000 for married couples filing jointly. To qualify, you must have lived in the home for at least two of the last five years before the sale. Ensure you meet these requirements to exclude gains from taxable income.

Navigating real estate taxes and deductions involves understanding key concepts and staying informed about changes in tax laws. Doing so can help you maximize savings and make smart decisions with your property investments.