Interest on your mortgage Whether you pay it to a lender or to a home seller or other party, interest on your mortgage is deductible as long as it's for debt secured by real property. Interest is deductible on a second or home equity loan up to $100,000. Your property taxes are completely deductible, but special government fees such as water or sewer assessment may not be. Loan points are fully deductible for a purchase mortgage, in the year that you pay them. In a refinance, you write off the points in increments over the term of the loan. What Isn't Deductible?
Home improvement expenses Homeowner and co-op dues Insurance expenses Retirement Savings and Real Estate Saving for a down payment is the most tax-effective way to buy a home compared to using your retirement savings. But tax rules have been relaxed somewhat to allow cash-strapped first-time buyers to tap these funds without paying the 10 percent penalty on early withdrawals. IRA Funds You now can draw up to $10,000 penalty-free from a conventional individual retirement account or a Roth IRA to buy your first home as long as you purchase your home within 120 days of withdrawing the funds. If you've owned a home before, but not in the past two years, you also qualify to make this withdrawal. You still pay state and federal income tax, however, which can cut that amount significantly. If you are in the 28 percent federal tax bracket, for example, you would net $7,800 on your withdrawal to go toward your home purchase, including the down payment and the closing costs listed above. Add in any state income tax and it would be less.
The Roth IRA comes with other caveats as well:
Deduct income not contributions Contributions to a Roth IRA are not deductible, but you don't pay taxes on qualified distributions. Must wait five years To be qualified for a Roth IRA, a distribution (withdrawal) must be made five taxable years after the first contribution to the account was made. In addition, the distribution must meet at least one of the following conditions:
Money used to buy first home Withdrawal made after account-holder is 59 Withdrawal made because account-holder becomes disabled Money distributed to beneficiary after account-holder's death Limits on the contribution You can contribute up to $3,000 a year to an account, but only if you're a single tax-filer with adjusted gross income of less than $95,000 or joint filers with combined income below $150,000. Convert your existing IRA carefully The new tax law permits you to convert your existing individual retirement account into a Roth IRA if your adjusted gross income is less than $100,000 and you are not married and filing separately. Any amount that would have been taxable as income when withdrawn from the existing account will be taxed. There are other limits; consult a tax professional for details. 401(k) Plans If you are participating in your employer's tax-deferred retirement plan, you can borrow up to a specified limit from that account penalty-free to buy a house for yourself or for a relative. A relative who participates in such a plan also can draw from his or her account to give to you as a gift or loan to buy a home. Tapping 401(k) funds isn't as easy as it sounds, however. Because you do have to pay the money back, your lender will count it as outstanding debt when calculating your income-to-debt ratios. If you are carrying too much other debt, you could be disqualified for your loan.
While the information contained in this section is considered to be current and accurate, you are advised to consult a Tax Professional before acting on this information.