Understanding federal tax rules for your home can save you thousands. This guide covers the key deductions, exclusions, and strategies every homeowner should know.
What Does Owner Occupied Mean for Federal Tax Purposes
Owner-occupied means you live in the property as your primary residence. The IRS typically requires you to:
- Live there for the majority of the year
- Use it as your main home for legal and financial purposes
- Generally reside there for at least 2 of the last 5 years for capital gains exclusion
This distinction determines which tax benefits you can claim and how the IRS treats your property-related income and expenses.
Mortgage Interest Deductions for Owner-Occupied Homes
The mortgage interest deduction is one of homeownership’s biggest tax benefits. You can deduct interest on mortgage debt up to $750,000 (loans after December 15, 2017) or $1 million (loans before that date).
What qualifies: Interest on mortgages used to buy, build, or substantially improve your home, including purchase points (deductible immediately) and refinance points (deductible over the loan’s life).
What doesn’t qualify: Home equity loan interest unless funds were used to improve the home, or interest exceeding the debt limit.
Important: You must itemize deductions to claim this benefit. The 2023 standard deduction is $13,850 (single) or $27,700 (married filing jointly).
Property Tax Deductions and SALT Limits
Property taxes on your home are deductible, but there’s a catch: the $10,000 SALT cap ($5,000 if married filing separately).
SALT includes your combined state and local taxes: property taxes, plus either state income taxes or sales taxes. If you pay $8,000 in property taxes and $5,000 in state income tax, you can only deduct $10,000 total, not $13,000.
Deductible: Annual property taxes and supplemental property taxes.
Not deductible: Transfer taxes, HOA fees, or service charges for utilities.
Capital Gains Exclusion on Primary Residence Sales
This is arguably the most powerful tax benefit for homeowners. You can exclude up to $250,000 of capital gains ($500,000 for married couples filing jointly) when you sell your primary residence.
To qualify, you need:
- Ownership test: Owned the home for at least 2 years in the 5-year period before the sale
- Use test: Lived in it as your primary residence for at least 2 years in that same period
The two years don’t need to be consecutive, and you can only use this exclusion once every two years.
Example: Buy a home for $300,000, sell for $550,000. A married couple pays zero capital gains tax on the $250,000 profit.
What reduces your exclusion:
- Prior depreciation (like from home office use) must be recaptured at 25%
- Business-use portions may not qualify
- Rental periods after 2008 can reduce the exclusion
Home Office Deductions for Owner-Occupied Property
Important: Only self-employed individuals and independent contractors can claim home office deductions. W-2 employees cannot, even if working from home.
Requirements: Your home office must be used regularly and exclusively for business, and be your principal place of business or where you meet clients.
Two calculation methods:
- Simplified: $5 per square foot, up to 300 sq ft (max $1,500 deduction)
- Regular: Deduct your business-use percentage of mortgage interest, property taxes, utilities, insurance, repairs, and depreciation
Caution: Claiming home office deductions can reduce your capital gains exclusion when you sell, and you’ll owe 25% depreciation recapture tax. For many homeowners expecting home appreciation, the simplified method or skipping the deduction entirely preserves more value at sale.
Depreciation Rules for Partial Owner Occupancy
When part of your property generates income, you must claim depreciation on that portion. This applies to:
- Renting out a basement apartment, ADU, or unit in a multifamily property
- Operating a business from dedicated space
- Short-term rentals through platforms like Airbnb
How it works: Depreciation is based on the income-producing percentage (by square footage or rooms), calculated over 27.5 years for residential rental property.
Example: Own a duplex, live in one unit, rent the other? You depreciate 50% of the building’s value over 27.5 years.
*Cost segregation opportunities. Where CSSI helps:
Properties with income-producing components can benefit significantly from cost segregation studies, which identify assets for accelerated depreciation.
Properties that qualify for cost segregation:
- Multifamily with owner occupancy (duplex, triplex, fourplex)
- Owner-occupied commercial properties where you operate your business
- Properties with rental basement units, ADUs, or separate rental spaces
- Mixed-use properties
Properties that DON’T qualify: Pure owner-occupied residential homes (single-family with no rental or business component) cannot use cost segregation. The property must have an income-producing element.
Important: When you sell, you’ll pay depreciation recapture tax (up to 25%) on all depreciation claimed, even if you convert back to full owner-occupancy.
Federal Tax Treatment of Home Improvements vs Repairs
Understanding this distinction is crucial because the tax treatment differs significantly.
Repairs maintain your property’s current condition. Generally not deductible for owner-occupied homes, but proportional costs may be deductible for rental/business portions.
Examples: Fixing leaky faucets, patching drywall, replacing broken glass, repainting, fixing gutters
Improvements add value, prolong life, or adapt to new uses. Not immediately deductible, but they increase your cost basis, reducing capital gains when you sell.
Examples: New room additions, roof replacement, new HVAC, kitchen/bathroom remodeling, new deck, window replacement, finishing basement
Why it matters: Track improvements carefully. A higher cost basis means lower capital gains at sale—especially valuable if your gain exceeds the $250,000/$500,000 exclusion.
Energy-efficient improvements: Recent legislation offers substantial credits for primary residence improvements:
- Up to $3,200 annually for heat pumps and related equipment
- Up to $600 annually for windows and skylights
- Up to $500 annually for exterior doors
- 30% credit for solar systems and geothermal (no annual limit through 2032)
These credits reduce your tax bill directly and don’t require itemizing.
Tax Implications When You Convert a Home to Rental Property
Converting your home to rental use requires careful planning but opens valuable tax opportunities.
Establishing basis: Your depreciable basis is the lower of your adjusted basis (original cost plus improvements) or fair market value at conversion. If your property declined in value, you can only depreciate the current market value.
What becomes deductible:
- Mortgage interest (no $750,000 limit)
- Property taxes (no $10,000 SALT cap)
- Insurance, utilities, repairs, maintenance
- Property management and advertising
- Depreciation on the building
Cost segregation value: When converting to rental, a CSSI cost segregation study can identify components for accelerated depreciation (5-year and 15-year property like carpet, appliances, landscaping, fencing), creating substantial first-year tax savings that can offset rental and other passive income.
Impact on future sale:
- You must still meet the 2-out-of-5-years use test for capital gains exclusion
- Post-2008 rental periods reduce your exclusion
- All depreciation taken must be recaptured at 25%
Smart strategy: Partial conversion (basement apartment, ADU) while continuing to live there lets you generate rental income and deductions while maintaining primary residence status for capital gains purposes. This provides rental benefits without sacrificing all owner-occupied advantages.
How CSSI Can Help
CSSI specializes in maximizing tax benefits through cost segregation studies. While purely owner-occupied residential properties don’t qualify, we can help if your property has income-producing components.
We work with:
- Owner-occupied commercial properties where you operate your business
- Multifamily properties where you live in one unit and rent others (duplex, triplex, fourplex)
- Properties with rental components like basement apartments or ADUs
- Mixed-use properties combining residential and commercial space
- Converted properties transitioning to full or partial rental use
What we do:
Our engineers and tax professionals conduct detailed analyses to identify all components eligible for accelerated depreciation. We reclassify assets into shorter depreciation periods (5-year and 15-year instead of 27.5-year), generating larger deductions in early ownership years.
When it makes sense:
Cost segregation typically benefits properties over $500,000 with income-producing elements, when you plan to hold for several years and have taxable income to utilize the deductions.
Get started: Contact CSSI for a complimentary consultation. We’ll review your property and provide clear guidance on whether cost segregation can deliver tax savings for your specific situation.
