Tax Credit vs. Tax Deduction: What All Homeowners Should Know
If you're a homeowner, you need to know which credits and deductions you are entitled to come tax time.
Homeownership can offer big tax benefits. And with recent mortgage loans costing more due to higher interest rates, doing everything you can to offset higher payments is more important than ever.
The good news is that you might be eligible for more credits and deductions than you might have guessed, especially if going green is on your agenda. It’s also important to understand the differences between credits and deductions, so you can understand each benefit’s impact on your tax scenario.
What is a tax credit?
A tax credit is a dollar-for-dollar income tax reduction. A credit of $100 means you pay $100 less in income tax, for example. The United States government rewards taxpayers with tax credits for engaging in activities considered helpful to issues they feel important, such as the economy and the environment. Particular guidelines concerning tax credits must be satisfied before one is eligible for these credits.
The three main types of tax credits include non-refundable, refundable, and partially refundable. A refundable tax credit is paid either as a check or a deposit to a taxpayer’s bank account, while a non-refundable tax credit can only reduce a taxpayer’s liability to zero. A taxpayer will have to forfeit any credit greater than the amount owed.
There are many categories of tax credits for individuals, including the following:
- Family and dependent credits
- Income and savings credits
- Homeowner credits
- Electric vehicle credits
- Health care credits
- Education credits
Homeowners can benefit from more than just the “homeowner credit” category. In fact, all of the tax credit categories could apply to people who own their own home. Nevertheless, here are the three common tax credits that are included as homeowner credits:
- Mortgage tax credit: The Mortgage Tax Credit Certificate program helps low-income, first-time homeowners afford a home. Those who qualify can claim a tax credit that reduces their tax bill dollar-for-dollar up to $2,000.
- Energy-saving improvements: Homeowners are eligible to receive a tax credit of 10 percent of the cost of purchasing energy-efficient items in categories such as air conditioning, skylights, and water heaters.There is also a flat tax credit of $50 to $300 for installing Energy Star-certified items like heat pumps, water heaters, or furnaces. Homeowners can receive a tax credit of up to 30 percent of the cost of eligible solar systems, wind turbines, and fuel cells.
- Owning and renovating a historic home: Federal and state tax credits are available for people who renovate a historic home. The credit amounts vary from state to state, and the credit is administered by the National Trust for Historic Preservation. While 35 states offer rehabilitation incentives, others offer an additional 25 percent credit for homeowners, and others give you credit if the property is income-producing. Keep in mind, however, that not all renovations are good for property owners, as some can raise your property taxes by increasing the value of your home.
What is a tax deduction?
A tax deduction allows taxpayers to deduct some expenses from their taxable income, reducing their overall tax bill. Taxpayers might claim the IRS-determined standard tax deduction amount, or they can claim itemized deductions.
A standard tax deduction is a set number, but one that typically rises each year due to inflation. All taxpayers are eligible for some standard income deductions.
Your filing status determines the amount of your standard tax deduction. In 2022, single and married taxpayers filing separately can claim a $12,950 standard deduction, while married couples filing jointly can claim double that number: $25,900.
Taxpayers who file as a “head of household” (unmarried individuals with dependents) can claim a standard deduction of $19,400.
2022 Marginal Income Tax Brackets
Your taxable income determines which federal tax bracket you fall into. There are seven brackets in total, each with its own marginal tax rate (the amount of additional tax paid for every additional dollar earned as income). Often these federal tax rates change year to year for inflation, and the beginning and ending dollar amounts can change as well.
|Tax Rate||Taxable Income for Single Filers||Taxable Income for Married Filers|
|10 percent||$10,275 and under||$20,550 and under|
|12 percent||Over $10,275 to $41,775||Over $20,550 to $83,550|
|22 percent||Over $41,775 to $89,075||Over $83,550 to $178,150|
|24 percent||Over $89,075 to $170,050||Over $178,150 to $340,100|
|32 percent||Over $170,050 to $215,950||Over $340,100 to 431,900|
|35 percent||Over $215,950 to 539,900||Over $431,900 to $674,850|
|37 percent||Over 539,900||Over 647,850|
Itemized deductions are specific, tax-deductible expenses incurred by the taxpayer. A taxpayer typically itemizes their deductions when expenses through businesses, charity donations, state or local income taxes, medical or dental expenses above adjusted gross income limits, mortgage interest, and property taxes exceed the deduction they would receive from the standard deduction.
Also itemizable are self-employment expenses and student loan interest payments. When itemized deductions have been subtracted from your income, the rest of your income is then taxable.
Itemized deductions need to be approved by the IRS and may help taxpayers lower their tax bill by a greater amount than they would with the standard deduction. The 2017 Tax Cuts and Jobs Act increased standard deductions, so filing for itemizing deductions might not be as necessary as they once were. Here are some of the most common tax deductions that homeowners should be aware of:
- Discount points: With interest rates rising in 2022, you may have decided to pay discount points to lower your tax rate on a refinance. The good news is that these points are tax deductible. However, you must spread that deduction out over the life of the loan.
- Property taxes: Property taxes vary from state to state. These state and local taxes are deductible, as are state income taxes and state and local sales tax. You can only deduct up to $10,000, though, for all of these state and local taxes combined.
- Interest on home equity loans and lines of credit: The interest on HELOANS and HELOCS is tax deductible if you use that money to improve your home substantially. Home furnishings do not qualify.
- Medically necessary improvements: Home improvements in support of a medical condition, such as support bars, ramps, and stair lifts are tax deductible.
- Home office expenses: If you are self-employed, you can deduct home office expenses as long as you use a dedicated office as your principal place of business.
Do you need a receipt for every itemized deduction?
You don’t necessarily receive a receipt for paying your mortgage interest, although your mortgage statement could serve as one.
If you are funding a renovation, a contractor might not give you a receipt for each payment you give them, but your records of payment (either through an electronic transfer or cashed check record) can serve as a receipt.
That is generally true of most types of tax-deductible payments. Even if you don’t have a receipt, you should always have definitive proof of payment.
Tax credit vs. deduction: which is more valuable?
Tax credits are generally more valuable than deductions because they reduce your tax liability on a dollar-for-dollar basis. For example, if a tax credit is for $1,000, you will pay $1,000 less in your taxes. A tax deduction, however, reduces the amount of your taxable income. The reduction is based on the percentage of your highest federal income tax bracket. For example, if you fall into the 35 percent tax bracket, a $1,000 deduction saves you $350.
However, itemized tax deductions should not be taken lightly because they can be sizable. With the increase in mortgage interest rates, for example, being able to deduct the interest paid on a mortgage can amount to thousands of dollars in savings.