Taxes 101: What to Know Before You File
March 7, 2023
Taxes are anything but simple. From income to credits, deductions, and filing deadlines, the system is complex. Whether you’re a do-it-yourself filer or you rely on a tax professional, Tax Day is coming. There are different deadlines for personal tax returns and for businesses. Personal tax returns (federal and state) are due this year on Tuesday, April 18. Tax Day comes earlier – Wednesday, March 15 – for some businesses such as partnerships, multi-member LLCs, and S-Corporations if they use a calendar year for taxes. Businesses that use a fiscal year must file by the 15th day of the third month following the close of their tax year. For example, a business with a fiscal year of October 1-September 30 would have a tax deadline of December 15.
The Homeowners Tax Advantage
Homeowners enjoy special federal and state income tax perks if you know how to claim them. Tax deductions and credits are a major benefit of homeownership, especially if you can itemize deductions. Mortgage interest, property taxes, home office expenses, some medically necessary home improvements, and energy saving tax credits can save homeowners thousands on their federal and state income tax bills.
First, determine whether your deductions exceed the standard deduction amount. An alternative to itemized deductions, the standard deduction is an allowance for medical, insurance, taxes, charitable and interest payments that may be subtracted from gross income. The standard deduction may change from year to year. For the 2022 tax year, the standard deduction is $12,950 if filing single. If married and filing a joint return, the standard deduction is $25,900.
If allowable deductions exceed the standard amount, itemizing may lower your tax bill. Itemized deductions are a detailed list of payments (substantiated with receipts) such as unreimbursed medical and dental expenses, some insurance premiums, state and federal tax payments, charitable contributions, and interest.
For homeowners, these key deductions may ease your federal and state taxes owed this year:
Mortgage Loan Interest – By far, this is the largest tax break for homeowners. – especially those with new mortgages where monthly payments are mostly interest. Interest paid in 2022 is deductible up to a limit depending on when you initiated the mortgage.
- Dec. 16, 2017 or later: Deduct interest on loans of up to $750,000 (or up to $375,000 if married and filing separately). Mortgage interest on a second home, which is also deductible, is included in the limit.
- Oct. 14, 1987 - Dec. 15, 2017: You can deduct the interest on a mortgage of up to $1 million ($500,000 if married and filing separately). If you refinanced an existing mortgage, the limit depends on the initial loan's origination date. If the original mortgage predates Oct. 14, 1987, all the mortgage interest may be deductible.
Home Equity Loan Interest – Interest paid on money borrowed through a home equity loan or home equity line of credit also may be deductible. To qualify, you must use the loan to buy a property, build your own home, or renovate your existing home. The amount of the loan or line of credit is considered part of the limits on deductible interest described above.
Points– At your mortgage closing, you may have paid discount points to reduce your interest rate and that amount may be deductible if you are within the limits of deducting your mortgage interest. Caution: Discount points to reduce the mortgage interest rate are not the same as loan origination points which are not deductible.
Property Taxes– Property taxes paid in 2022 are deductible. Combined with other state and local taxes that are deductible there is a limit of $10,000 or $5,000 if married and filing separately. Taxes paid before the sale of a home in 2022 also are deductible.
Home Office – The pandemic created a need for many workers to create a home office in order to work remotely. However, not everyone who has an office at home may claim a tax deduction. Home office expense deductions are allowable only if you’re self-employed and use part of your home regularly and exclusively for your business. The Internal Revenue Service has a simple chart here to help you see if your home office expenses are deductible.
Medically Necessary Home Improvements– Some home improvement expenses may be tax deductible if they are deemed medically necessary. Installing entrance ramps, railings, and grab bars or widening doorways are likely deductible. However, if the improvements increase the property’s value the amount of the deduction may be decreased by the amount of the property value increase. A good example would be enlarging a shower to provide easier access. The cost of improvements may not be deductible if the larger shower increases the home’s value more than the allowable deduction.
Capital Gains – Most capital gains – the profit realized by selling a home for more than you paid for it – are taxable. You may be eligible for an exclusion of up to $250,000 (filing single) or $500,000 (married, filing jointly) if the house was your principal residence for two years or more in the five years before selling it. The IRS allows you to exclude real estate capital gain up to $250,000 if you’re single or $500,000 if married and filing jointly. If you have claimed the exclusion on another home within two years before the sale of your current home, you are not eligible for the exclusion.
Alabama’s First Time/Second Chance Homebuyer Tax Deduction – Alabama residents saving money for their first home may reduce their gross income for state taxes through special savings accounts authorized by state law. Money deposited, subject to annual limits, and the interest earned is not taxed. Annual deduction limits are $5,000 for individuals and $10,000 for couples filing jointly. The total of principal and earnings is limited to $25,000 for individuals and $50,000 for couples filing jointly. The program also applies to any homebuyer who has not purchased a home within 10 years. To be tax free, money in the account must be used for a down payment or other closing expenses listed on a closing statement. The program is set to expire December 31, 2028.
The Bottom Line
Your home is an excellent investment in the long run because it helps you not only build up equity but also reap substantial tax breaks and save money. If you haven’t started already, gather those tax forms and receipts for possible deductions. Decide whether to tackle your return yourself or make an appointment with a tax professional well before the filing deadline. Whether the result is owing the IRS less or getting a nice refund, your reward will be well worth the effort.