Tax time is upon us and you may have questions regarding the use of tax credits and tax deductions as they relate to your real estate holdings.
If you’re considering the purchase of a new home you may qualify for the federal government’s home buyer tax credit offering up to $8,000 for first time buyers and up to $6,500 for repeat buyers. If you’re planning some green improvements to your home you may be eligible for a tax deduction offered by government agencies for installing energy efficient products in your home.
To understand which option might be better for you it helps to understand the difference between a tax credit and a tax deduction, and how they each affect you financially.
Tax Credits
A tax credit gives you a dollar for dollar reduction in the amount of income tax you owe the federal government on your personal income taxes. For instance, if your income is $50,000 per year and you determine your tax due is $10,000 (20 percent tax) for the year and you qualify for an $8,000 tax credit, you would owe only $2,000 in taxes ($9,000 – $8,000 = $2,000).
Tax Deduction
A tax deduction works in a similar way, but with one main distinction. A deduction will reduce your taxable income, which lowers your total tax due, but not dollar for dollar with the deduction amount. Using the example above, a tax deduction of $8,000 would lower your taxable income to $42,000 ($50,000 – $8,000 = $42,000), from which your tax due would then be $8,400.
The $8,000 deduction reduces your tax due from $9,000 to $8,400, but it is still $6,400 higher than what you’d owe with a tax credit ($2,000). You can see that a tax credit is a more powerful tool than a tax deduction and has the potential to save you much more money on your tax returns.
