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Buying a home creates tax benefits that can reduce annual tax liability. Understanding these benefits from day one ensures proper documentation and maximizes available deductions. The most significant tax consideration when buying is establishing accurate cost basis, which affects taxes when you eventually sell.

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Establishing Cost Basis

Cost basis is your starting point for calculating gain or loss when you sell. It includes more than just the purchase price.
Purchase price plus certain closing costs:
  • Title insurance (owner’s policy)
  • Title search and abstract fees
  • Recording fees
  • Survey costs
  • Transfer taxes (if paid by buyer)
  • Legal fees related to purchase
  • Back taxes owed by seller that buyer pays
These costs cannot be deducted in the year paid. Instead, they increase your basis, reducing taxable gain when you sell.
Some closing costs are either deductible or simply not includable:Deductible in year paid (not added to basis):
  • Prorated property taxes
  • Prorated mortgage interest
  • Points (may be deductible or amortized)
Not deductible or added to basis:
  • Homeowners insurance premiums
  • Fire or hazard insurance
  • HOA fees
  • Utility adjustments
  • Home warranty premiums
When you sell, gain is calculated as sale price minus basis.
Example:
  • Purchase price: $300,000
  • Qualifying closing costs: $8,000
  • Basis: $308,000
  • Later improvements: $50,000
  • Adjusted basis: $358,000
  • Sale price: $500,000
  • Gain: $142,000
Higher basis means lower taxable gain. Keep records of all costs that increase basis.
Keep your settlement statement (Closing Disclosure or HUD-1) permanently. You’ll need it to calculate basis when you sell, which may be decades later.

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Mortgage Interest Deduction

Interest paid on mortgage debt is generally deductible if you itemize deductions.
Deductible on mortgage debt up to:
  • $750,000 for loans originated after December 15, 2017
  • $1,000,000 for loans originated before December 16, 2017
Limits apply to combined mortgage debt on primary residence and one second home.
  • Primary residence mortgage
  • Second home mortgage
  • Home equity loan used to buy, build, or improve the home
Home equity debt used for other purposes (car, vacation, debt consolidation) is not deductible under current law.
Must itemize deductions to claim mortgage interest. If standard deduction exceeds your itemized deductions, mortgage interest provides no tax benefit.2024 standard deduction: $14,600 (single), $29,200 (married filing jointly).Many homeowners find standard deduction exceeds their itemized deductions, especially with lower mortgage balances.
At closing, you pay prorated interest from closing date to end of month. This appears on your Closing Disclosure and is deductible in the year paid.Lender sends Form 1098 showing mortgage interest paid each year.

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Property Tax Deduction

Property taxes are deductible if you itemize, subject to limits.
State and local tax (SALT) deduction is capped at $10,000 total ($5,000 if married filing separately).This cap combines:
  • State income taxes (or sales taxes)
  • Local income taxes
  • Real property taxes
In high-tax states, property taxes alone may exceed the cap.
At closing, you may pay:
  • Prorated taxes for period you’ll own property
  • Escrow deposit for future taxes
Only actual tax payments are deductible, not escrow deposits. Prorated taxes paid at closing are deductible in the year paid.

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Points Deduction

Points (also called loan origination fees or discount points) are prepaid interest charged by lenders.
Points may be deducted in the year paid if:
  • Loan is secured by primary residence
  • Points are standard practice in your area
  • Points don’t exceed typical amount charged
  • You use cash accounting (most individuals do)
  • Settlement statement clearly shows points
  • Funds brought to closing equal or exceed points
Must spread deduction over loan life if:
  • Loan is for second home
  • Points are for refinancing (generally)
  • Requirements above aren’t met
Example: $3,000 in points on 30-year refinance = $100 deduction per year.
Generally must be amortized over loan term. Exception: Points allocable to portion used for home improvements may be deductible immediately.If you refinance again before full amortization, remaining unamortized points become deductible in that year.

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Tax Credits for Buyers

Credits reduce taxes dollar-for-dollar, making them more valuable than deductions.
State or local program providing tax credit for portion of mortgage interest paid. Available to first-time buyers meeting income limits.Credit typically 20-40% of interest paid, up to annual limit. Reduces amount of interest available for itemized deduction.Must obtain MCC before closing. Check state housing finance agency for availability.
Credits available for qualifying improvements:
  • Solar panels and solar water heaters
  • Geothermal heat pumps
  • Small wind turbines
  • Battery storage
  • Energy-efficient windows, doors, insulation (limited)
Residential Clean Energy Credit: 30% of cost for major systems, no cap.Energy Efficient Home Improvement Credit: 30% up to annual caps for specific items.
Various state and local credits exist. Availability and terms vary by location.Check state housing agency and local programs. Some require application before purchase.

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First-Year Tax Considerations

Retain permanently:
  • Closing Disclosure or HUD-1 settlement statement
  • Purchase contract
  • Deed
  • Title insurance policy
  • Appraisal
  • Inspection reports
  • Any improvement receipts from day one
If you’re newly itemizing due to mortgage interest and property taxes, you may be overwithholding. Consider adjusting W-4 to increase take-home pay.Conversely, if deductions don’t exceed standard deduction, no adjustment needed.
Tax deductions are based on taxes actually paid, not escrow deposits. Your lender pays property taxes from escrow when due.First year can be confusing. Review Form 1098 and property tax records to determine what was actually paid to taxing authority.

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Special Situations

Each owner deducts only their share of mortgage interest and property taxes actually paid.If one person pays entire mortgage, only that person can deduct interest (unless other contributes and is reimbursed).Keep records of who paid what.
Gift itself is not taxable to recipient. Donor may need to file gift tax return if gift exceeds annual exclusion ($18,000 per person in 2024).Gift doesn’t affect buyer’s basis. Lender requires gift letter documenting funds aren’t a loan.
Below-market purchases may have gift tax implications for seller. Buyer’s basis is purchase price paid, even if below market value.Document fair market value and actual purchase price. Consult tax professional for significant discounts.
Mortgage interest deductible on one second home (combined with primary residence within debt limits).Property taxes subject to SALT cap.If rented part of year, different rules apply. See rental property section.
Tax rules change frequently. Deduction limits, credit amounts, and eligibility requirements are subject to modification. Verify current rules apply to your situation.

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