Tax Strategies for Saving on Your Home and Real Estate
Owning real estate can offer significant tax advantages, whether it’s a primary residence, a vacation home, or a rental property. Here’s a detailed look at strategies and key considerations for maximizing tax savings:
1. Home-Related Tax Deductions
Property Tax Deduction
Current Limit: Under the Tax Cuts and Jobs Act (TCJA), through 2025:
Deduction for state and local taxes (SALT) is capped at $10,000 (or $5,000 for married filing separately).
Impact: High-income taxpayers in states with high property taxes have seen reduced federal tax benefits.
Mortgage Interest Deduction
Current Rules:
Deductible on mortgage debt up to $750,000 for loans incurred after Dec. 15, 2017.
Pre-existing loans (before Dec. 15, 2017) retain the higher limit of $1 million.
Deduction applies to interest on loans for purchasing, building, or improving your principal or secondary residence.
Points paid on your mortgage may also be deductible.
Post-2025: The limit reverts to $1 million, unless Congress extends the current TCJA provisions.
Home Equity Debt Interest Deduction
Interest on home equity loans or lines of credit is deductible only if the funds are used for qualifying purposes (e.g., home improvements).
Interest on loans used for non-qualifying purposes (e.g., buying a car) is not deductible.
2. Home Office Deduction
Eligibility
Self-Employed Individuals:
The home office must be:
Your principal place of business, or
Used exclusively and regularly for business purposes.
Employees: Cannot deduct home office expenses through 2025 due to the suspension of miscellaneous deductions under the TCJA.
Calculation Methods
Detailed Method:
Deduct a portion of expenses such as:
Mortgage interest
Property taxes
Utilities
Insurance
Claim depreciation for the business-use portion of your home.
Use Form 8829 to calculate the deduction.
Simplified Method:
Deduct $5 per square foot for up to 300 square feet (maximum $1,500 annually).
Easier to calculate but excludes depreciation.
Caution: The home office must be exclusively used for business. Shared use with personal activities disqualifies the deduction.
3. Energy-Efficiency Credits
Recent legislation offers incentives for making homes more energy-efficient:
Energy Efficient Home Improvement Credit
Applies to Existing Homes Only: Eligible improvements include:
Energy-efficient windows, doors, and insulation.
Advanced HVAC systems.
Credit Amount: 30% of qualifying expenses, up to $1,200 per year (2023–2032).
Residential Clean Energy Credit
Applies to New and Existing Homes: Eligible installations include:
Solar panels
Geothermal heat pumps
Small wind turbines
Credit Amount: 30% of installation costs, with no annual or lifetime limit (2023–2032).
4. Selling Your Home or Real Estate
Principal Residence Exclusion
If you sell your primary residence, you can exclude:
Up to $250,000 of capital gains (single filers).
Up to $500,000 (married filing jointly).
Eligibility Requirements:
Owned and lived in the home for at least 2 of the last 5 years before the sale.
Gain exceeding the exclusion amount is taxed as capital gains.
Depreciation Recapture
If you’ve claimed depreciation (e.g., for a home office), the portion of gain attributable to depreciation is subject to recapture at a maximum rate of 25%.
5. Real Estate as an Investment
Rental Property Deductions
Deductible expenses include:
Mortgage interest
Property taxes
Depreciation
Maintenance and repairs
Property management fees
Passive Activity Rules
Losses from rental properties are generally considered passive losses.
Passive losses can only offset passive income, unless:
You are a real estate professional meeting material participation requirements.
6. Planning for 2026 and Beyond
Several provisions of the TCJA are set to expire after 2025, potentially increasing tax benefits:
Property tax and mortgage interest deduction limits will revert to pre-TCJA rules.
Employees may again deduct home office expenses.
7. Rental Property Rules
Short-Term Rentals (Less Than 15 Days Per Year)
Tax Implications: Income from renting out your primary or secondary residence for fewer than 15 days is not taxable.
Limitations: Expenses directly tied to the rental (e.g., advertising, cleaning) are not deductible.
Renting 15 Days or More
Reporting Requirement: Income must be reported.
Expense Deductions: Deductible expenses depend on whether the property is classified as a rental or nonrental property:
Rental Property:
Deduct all expenses associated with rental use, including losses (subject to passive activity rules).
Property tax attributable to rental use is not subject to the $10,000 SALT deduction limit under the TCJA.
Mortgage interest tied to personal use is not deductible for the rental portion, though the personal portion of property taxes remains deductible (subject to the SALT cap).
Nonrental Property:
Rental expenses can only be deducted up to rental income. Excess expenses can be carried forward to future years.
Mortgage interest and property taxes for personal use are deductible (subject to limits).
Consider reducing personal use to classify the property as a rental property for greater tax benefits.
8. Selling Real Estate
Principal Residence Sales
Capital Gain Exclusion:
Exclude up to $250,000 of gain ($500,000 for joint filers) if:
You owned and lived in the home for at least 2 of the last 5 years.
Gain excluded from income is also exempt from the Net Investment Income Tax (NIIT).
Nonqualified Use:
Any gain attributable to periods of nonqualified use after 2008 (e.g., when the property is not your principal residence) is not excluded.
Losses:
Losses on the sale of personal-use residences are not deductible, but losses on business or rental portions of the home may be deductible (subject to limitations).
Second Home Sales
Ineligible for the principal residence exclusion.
Consider converting the property to a rental before selling to:
Defer gains through a 1031 exchange.
Deduct losses attributable to value declines after the conversion.
9. Investment Real Estate Activities
Passive Activity Rules
Passive Income and Losses:
Income is subject to the NIIT.
Losses are deductible only against passive income, with any excess carried forward.
Real Estate Professional Status:
To avoid passive loss limitations:
Perform more than 50% of personal services in real property trades or businesses.
Work at least 750 hours annually in these activities.
Maintain thorough records of time spent to withstand IRS scrutiny.
Special rules for spouses may help meet the material participation requirement.
Depreciation-Related Breaks
Qualified Improvement Property (QIP):
Improvements like roofing, HVAC systems, and alarm systems qualify for a 15-year recovery period and may be eligible for bonus depreciation or Section 179 expensing.
Section 179 Expensing:
Deduct the full cost of qualified property (e.g., tangible personal property for furnishing lodging) in the year of purchase, subject to limits.
Bonus Depreciation:
Allows for 100% first-year depreciation of qualified assets, though businesses electing to fully deduct business interest expense are ineligible.
10. Selling Investment Real Estate
Deferring Gains
Installment Sale:
Spread taxable gains over multiple years as payments are received.
Ordinary income from depreciation recapture must be recognized in the year of sale, even if no cash is received.
Potential drawback: Higher tax rates in the future could increase your liability.
1031 Exchange:
Defer capital gains tax by exchanging one investment property for another.
Risk: Future tax increases or changes in rules could result in higher taxes when the replacement property is sold.