Buying a home is one way to reduce your income taxes. The qualified mortgage interest you pay and your real estate taxes are both deductible.

Itemizing Deductions

With the purchase of your first home, you'll probably be eligible to change from using the standard deduction to itemizing deductions on Schedule A. The majority of taxpayers who purchase a home begin itemizing their deductions.

Claiming the Mortgage Interest Deduction

• Mortgages you took out on or before Oct. 13, 1987 (called grandfathered debt)
• Mortgages you took out after Oct. 13, 1987, to buy, build or improve your home, but only if these mortgages plus any grandfathered debt totaled $1 million or less throughout 2007 ($500,000 if Married Filing Separately)
• Mortgages you took out after Oct. 13, 1987, other than to buy, build or improve your home, but only if these mortgages totaled $100,000 or less throughout 2007 ($50,000 if Married Filing Separately) and all mortgages on the home totaled no more than its fair market value

If 1 or more of your mortgages doesn't fit into any of these categories, refer to Publication 936 to figure the amount of interest you can deduct.

Deducting Loan Origination Fees

The term "points" is used to describe certain charges paid to obtain a home mortgage. One point equals 1% of your loan. Points you pay (and even points the seller pays) when you purchase your home are generally deductible in full the year you pay them.

• Your loan is secured by your main home (the one you live in most of the time).
• Paying points is an established business practice in your area.
• The points paid weren't more than the amount generally charged in that area.
• You use the cash method of accounting (you report income the year you receive it and deduct expenses the year you pay them).
• The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees or property taxes.
• You provided funds at or before closing that were at least as much as the points charged, not counting points paid by the seller (you cannot have borrowed the funds from your lender or mortgage broker to pay the points).
• You use your loan to buy or build your main home.
• The points were computed as a percentage of the principal amount of the mortgage.
• The amount is clearly shown on your settlement statement.

Alternatively, you may amortize the points over the term of your mortgage.

Gaining on the Sale of Your Home

When you decide to sell your home, the IRS allows you to exclude gains on the sale from taxable income, up to $250,000 ($500,000 if Married Filing Jointly). You generally may claim this exclusion only once in any 2-year period. However, a loss on the sale of your home is not deductible.

--content provided by irs.gov

For help preparing your tax return, use TaxCut Software, TaxCut Online or talk to a tax professional.