The Best Tax Incentives For First-Time Homebuyers

Have you ever wondered what the best tax incentives for first-time homebuyers are?

Nearly a decade removed from the onset of the Great Recession, the economy has finally started to build some momentum of its own. Just about every economic indicator is in a better place than it was three short years ago. Most of the jobs that were lost after the downturn have returned, people are finally starting to make more money, and job security isn’t nearly as big of an issue as it was during the worst parts of the recession.

Recent improvements in the economic standing of our nation’s youth have made the prospect of saving money a reality. Of particular importance, however, is what building up a savings account means for millennials: the potential to own a home. If that wasn’t enough, first-time homebuyers are awarded certain tax incentives that make the idea of homeownership more attractive than ever.

“Tax-wise, this is a good time to buy,” said Yvette Best of tax preparation company Best Services Unlimited. “Homeownership offers tax breaks that renters do not have.”

First-time homeowners need to be aware of the incentives that can significantly reduce their tax liability and offset the cost of ownership. Let’s take a look at a few of the tax incentives first-time homebuyers can’t afford to miss out on.

First-Time Homebuyer Tax Incentives

I want to make it abundantly clear; the following incentives are some of the options first-time homebuyers have at their disposal, and are not representative of incentives made available to everyone. Do not attempt to claim any of the following incentives without consulting a professional tax advisor. Talk with a tax professional to see if you qualify for some of the best tax incentives made available to first-time homebuyers.

Savvy homebuyers should be able to save thousands of dollars if they qualify for the following tax incentives:

1. Mortgage Payment Interest Deduction

One tax deduction, more so than any other, is capable of providing first-time homeowners with a game-changing tax break: the mortgage payment interest deduction. This one, for what it’s worth, is the deduction most people are referring to when they emphasize the benefits of homeownership, at least as they relate to tax incentives. Some people have even come to rely on this deduction every year, as it can add up to a relatively large sum.

It is important to note that the mortgage payment interest deduction is especially beneficial to first-time homebuyers and those with newer mortgages. If for nothing else, loans are typically front loaded with interest payments.

“The way that loan amortization works, your first payments will have the highest ratio of interest to principal so you will receive the majority of the tax benefit upfront,” said Andrew Christakos, an accredited investment fiduciary with Westfield Wealth Management.

As its name suggests, the deduction accounts for the interest paid on a respective loan (up to $1 million). According to the Internal Revenue Service (IRS), “home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.”

With a few exceptions, borrowers are typically allowed to deduct every cent of the interest they incur. How much is actually deducted, however, will depend on a variety of factors: the date of the mortgage, the amount of the mortgage and how the mortgage proceeds are used.

2. Mortgage Credit Certification

The Mortgage Credit Certification (MCC) program represents an effort to help lower-income families make the transition into homeownership. Unlike the mortgage payment interest deduction, the MCC doesn’t reduce the taxable income of an individual, but rather acts as a credit against an individual’s tax bill and reduces the amount owed to Uncle Sam.

The MCC program is essentially a way for first-time homeowners to offset a portion of their mortgage interest as a means of qualifying for a loan. While there are some exceptions, MCCs are only issued to first-time homebuyers taking on their first mortgage.

According to the IRS, “the MCC will show the certificate credit rate you will use to figure your credit. It also will show the certified indebtedness amount. Only the interest on that amount qualifies for the credit.”

“To claim the credit, complete Form 8396 and attach it to your Form 1040 or Form 1040NR, U.S. Nonresident Alien Income Tax Return. Include the credit in your total for Form 1040, line 54, or Form 1040NR, line 51; be sure to check box c and write “8396” on that line.”

Not to be confused with your standard tax deduction, MCCs are in fact a credit. Those looking to acquire a loan can add the credit they receive to their income, making it easier to qualify. While not technically income, the credit reduces tax obligations, putting more money in the borrowers pockets. That’s why it’s not uncommon for people that qualify for MCCs to use them for acquiring FHA, USDA, and VA home loans. What’s more, the credit may help first-time homebuyers qualify for a bigger loan.

“It’s a little-known but very cool program,” said Deb Tomaro, a broker with RE/MAX Acclaimed Properties in Indiana. “Depending on the purchase price of your home, a buyer can get 20% to 30% of the interest they pay every year on their mortgage back as a straight tax credit — straight back into their pocket.”

3. Mortgage Points Deduction

Very few homeowners are aware that they can deduct more than just the interest they pay on their monthly mortgage. It is entirely possible to deduct the points paid to secure a mortgage loan. Since points represent prepaid interest, this incentive works a lot like the mortgage payment interest deduction.

According to the IRS, “the term points is used to describe certain charges paid to obtain a home mortgage. Points are prepaid interest and may be deductible as home mortgage interest, if you itemize deductions.”

However, like most tax incentives, there are strict rules to follow. “If you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage. If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.”

There is no reason to believe that the mortgage points deduction couldn’t amount to thousands of dollars for first-time homebuyers. Even in the face of historically low interest rates, buying points to reduce your own rate could be a great move. In doing so, you are permitted to deduct the cost of the points and the amount you paid in interest in the same year you purchased the home.

4. Tax-Free IRA Withdrawals

I want to encourage those that have already bought a home to consider the great tax advantages that coincide with homeownership. However, no less important are the incentives that have become synonymous with the actual process of purchasing a property. Tax incentives are made available to those in the process of buying their first home; that is if they dip into their IRA.

“First-time homebuyers who break into their IRAs to come up with the down payment do not have to pay the 10% penalty normally applied to pre-age 59 1/2 withdrawals,” Greene-Lewis said. “This incentive also applies to current homeowners as well, since you are eligible for first-time buyer status if you have not purchased a home in two years.”

Whereas breaking into an IRA account early is typically met with harsh penalties, buying a home is an exception to the rule. First-time homebuyers are allowed to dedicate up to $10,000 from their IRA toward the purchase of their first home. Those that are married can double that number, pulling up to $10,000 from each account. That’s $20,000 towards a home that won’t be penalized by the IRS for early withdrawal.

You must exercise caution when pulling from an IRA; don’t take the money out too soon. Funds taken out of an IRA to purchase a home must be used within 120 days to pay qualified acquisition costs: buying costs, building costs, financing costs and closing costs.

First-time homebuyers need to be aware of the tax incentives that can reduce their tax liabilities and offset the cost of ownership. Don’t let these opportunities pass you by just because you are unfamiliar with how they work. Consult a tax professional and see if you can start saving today.