Many new home buyers are under the impression that paying mortgage interest will automatically provide a big write-off and tax savings. In reality, that may or may not be the case. For the first-time home buyer, getting a mortgage means that you can now itemize your deductions rather than using the standard deduction. Your tax savings depend on how much more you have to itemize than the standard deduction allows.
Note the current standard deduction for your federal tax filing status. For 2013, the standard deduction amounts by filing status are the following: Single: $6,100 Married filing jointly: $12,200 Head of household: $8,950 Married filing separately: $6,100
Determine your marginal tax bracket. For 2013, the federal income tax brackets range from 10 to 39.6 percent, with the majority of tax payers falling into the 25, 28, 33 or 35 percent brackets. You pay different rates on different levels of income and your marginal bracket is the highest rate you pay based on your annual taxable income. You can get your marginal tax bracket from tax rate tables or the IRS tax return instructions booklet.
Determine the deduction amounts you will have from the purchase and financing of a home. Deductible home-related items include mortgage interest you pay during the year, mortgage insurance premiums you pay and the property taxes on your home. Add up the totals for these costs over the course of a calendar year.
Look up or estimate other payments you make that would be deductible if you itemized your deductions. Another likely deduction category is state income tax or the amount of general sales tax you pay during the year. You can deduct one or the other state collected tax type but not both. Another possible deduction is charitable contributions, including cash and donation of goods.
Total together the two groups of potential itemized deductions. Most individuals cannot use the second group unless they own a home and the interest deduction puts them near or over the standard deduction, which allows the smaller deductible items to help reduce your tax bill.
Subtract your standard deduction amount from your estimated total of itemized deductions. For example, if your status is married filing jointly and your total itemized deductions are $16,000, the different would be $3,800 -- $16,000 minus $12,200.
Multiply the amount of your deductions that is greater than the standard deduction by your marginal tax bracket to find the amount of tax savings you would get from having a mortgage and paying tax-deductible interest. For the example if you are in the 28 percent tax bracket, that percentage times the $3,800 in extra deductions means that buying a home with a mortgage would save you $1,064 in federal income taxes.
Other possible tax deductions include medical expenses above 7.5 percent of your annual income, casualty or theft losses and unreimbursed job expenses. These items would also increase your total deductions and reduce your income tax bill.
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