Ah, tax deductions—the silver lining to the often eye-watering cost of buying a home in California! After helping clients navigate the Golden State’s real estate market for over two decades, I’ve seen firsthand how understanding tax benefits can make a significant difference in the financial equation of homeownership.
Let me tell you, when I bought my first place in Silver Lake back in 2003, I had no idea about half these deductions. I probably left thousands of dollars on the table those first few years! That’s why I always make a point to have this conversation with my clients—especially first-time buyers who are already stretching their budgets in our competitive market.
Mortgage Interest Deduction: Still Valuable in California Despite Changes
The mortgage interest deduction has long been the crown jewel of homeowner tax benefits, though it underwent significant changes with the 2017 Tax Cuts and Jobs Act.
Here’s what California homeowners need to know:
- You can deduct interest on up to $750,000 of mortgage debt for loans taken out after December 15, 2017
- For mortgages originated before that date, the limit remains at $1 million
- This applies to debt used to buy, build, or substantially improve your primary residence or second home
Now, here’s where it gets interesting for California specifically. Given our state’s high home prices, many of my clients—especially in places like West LA, Pasadena, or anywhere in the Bay Area—bump up against these limits. The median home price in Los Angeles County is hovering around 750,000 doesn’t go nearly as far as it would in most of the country.
I remember helping a young tech couple buy their first home in Burbank last year. They were initially discouraged about the tax benefits because their loan was just over the 750,000, which translated to substantial tax savings even though they couldn’t deduct 100% of their interest.
Pro tip: Your mortgage lender will send you Form 1098 in January showing how much interest you paid the previous year. Keep this document for your tax preparer!
Property Tax Deductions: Limited But Still Valuable
Property taxes represent another significant deduction, though again, the 2017 tax law changed the landscape here.
Currently:
- State and local tax (SALT) deductions, which include property taxes, are capped at $10,000 for both single filers and married couples filing jointly
- This cap includes state income taxes as well as property taxes
This $10,000 SALT cap hits Californians particularly hard. Between our state’s high income tax rates and substantial property tax bills (even with Proposition 13 protection), most of my clients in middle to upper-income brackets easily exceed this limit.
For context, a $1 million home in Los Angeles County generates a property tax bill of roughly 13,000 annually—already exceeding the cap before considering any state income taxes!
Between you and me, this SALT cap is one of the most frustrating changes for California homeowners. I’ve had clients in places like Sherman Oaks and Redondo Beach who were counting on these deductions to help offset their housing costs, only to find the benefits significantly reduced.
That said, 10,000—it’s worth claiming every penny you’re entitled to.
Points and Closing Costs: The Often-Overlooked Deductions
Here’s where many new homeowners miss out on valuable deductions: certain closing costs and mortgage points.
If you paid points to reduce your interest rate (each “point” equals 1% of your loan amount), you may be able to deduct this expense. The rules vary depending on whether the points qualify as:
- Immediately deductible: If the points were paid to reduce your interest rate on your primary residence, they might be fully deductible in the year you paid them
- Amortized over the loan term: Some points must be deducted gradually over the life of the loan
I had clients purchasing in Manhattan Beach who paid 2 points on their 18,000! They were able to deduct this amount on their first year’s tax return, which significantly reduced their tax burden that year.
Other potentially deductible closing costs include:
- Prorated property taxes paid at closing
- Mortgage interest paid at closing
- Certain mortgage insurance premiums (subject to income limitations)
Your final closing statement (often called the Closing Disclosure or Settlement Statement) itemizes these costs. I always advise my clients to share this document with their tax professional—don’t just file it away!
Home Office Deductions: Increasingly Relevant for Californians
Since the pandemic, I’ve seen a dramatic shift in how my clients use their homes. That spare bedroom or den has transformed into a legitimate workspace for many Californians.
If you use part of your home exclusively and regularly for business purposes, you may qualify for the home office deduction. There are two methods to calculate this:
- Simplified method: Deduct $5 per square foot of your home office (up to 300 square feet)
- Regular method: Calculate the actual expenses of your home office, including the percentage of your mortgage interest, property taxes, utilities, repairs, and depreciation
Elena, my wife, has been working from home for years and has found the regular method typically yields a higher deduction, though it requires more detailed record-keeping.
Important caveat: If you’re a W-2 employee (even if you’re working remotely), you generally cannot take the home office deduction. This benefit is primarily available to self-employed individuals, independent contractors, and small business owners.
Energy Efficiency Tax Credits: California’s Green Advantage
California leads the nation in environmental initiatives, and this extends to tax incentives for energy-efficient home improvements.
Beyond the federal tax credits available nationwide, California offers additional incentives through programs like:
- Property tax exclusions for certain solar energy systems
- Tax credits for energy storage systems
- Various utility company rebates that, while not tax deductions per se, reduce your overall cost
I worked with a family in Pasadena last year who installed solar panels on their new home immediately after purchase. Between the federal tax credit (30% of the system cost) and local incentives, they recouped nearly 50% of their investment in the first year.
The Inflation Reduction Act of 2022 significantly expanded these credits, making energy improvements more attractive than ever. Qualifying improvements include:
- Solar panel installations
- Energy-efficient windows and doors
- Heat pumps and water heaters
- Electric panel upgrades
- Battery storage systems
California-Specific Considerations and Programs
Our state offers some unique programs that can affect your tax situation as a homeowner:
Mills Act Property Tax Abatement
If you’ve purchased a historic home in California, you may qualify for property tax reductions under the Mills Act. This program provides tax relief to owners who agree to maintain and preserve historic properties.
I helped clients purchase a gorgeous 1920s Spanish Colonial in Los Feliz that qualified for Mills Act status. Their property tax bill was reduced by about 40%—a substantial saving in an area with high property values.
Proposition 13 Protection
While not a deduction per se, California’s Proposition 13 limits property tax increases to 2% annually, regardless of the actual increase in your home’s value. This isn’t something you claim on your taxes, but it’s a significant financial benefit for long-term California homeowners.
When you purchase a home, your property tax is initially based on your purchase price. This becomes your baseline for future Prop 13 protection.
Proposition 19 Considerations
Effective April 2021, Proposition 19 changed the rules for transferring property tax assessments in California. If you’re 55 or older, severely disabled, or a victim of natural disaster, you may be able to transfer your property tax base from your old home to a new one anywhere in California.
I recently helped a retired couple sell their longtime home in Glendale and purchase a smaller property in Ojai. Thanks to Prop 19, they kept their favorable property tax assessment from their original home, saving them thousands annually.
First-Time Homebuyer Considerations
If you’re a first-time homebuyer in California, pay special attention to these potential benefits:
Mortgage Credit Certificate (MCC) Program
This program allows qualified first-time homebuyers to convert part of their mortgage interest into a direct tax credit. The credit is typically 20% of the mortgage interest paid annually.
Unlike a deduction that reduces your taxable income, a credit directly reduces your tax bill dollar-for-dollar. For a homeowner paying 3,000!
First-Time Homebuyer Retirement Account Withdrawals
While not California-specific, first-time homebuyers can withdraw up to $10,000 from IRA accounts without the usual 10% early withdrawal penalty (though you’ll still pay income tax on the withdrawal in most cases).
Common Tax Deduction Mistakes California Homeowners Make
After two decades of helping California homebuyers, I’ve seen some common tax mistakes:
Mistake #1: Not keeping track of home improvements
Major home improvements can increase your cost basis, potentially reducing capital gains tax when you sell. I advise all my clients to create a dedicated file—digital or physical—for receipts and contracts for significant home improvements.
Mistake #2: Assuming the standard deduction isn’t worthwhile
With the increased standard deduction (27,700 for married couples filing jointly in 2023), some homeowners assume itemizing isn’t worth the effort. However, given California’s high housing costs, many homeowners still benefit significantly from itemizing.
Mistake #3: Forgetting about property tax reassessments
In California, certain property transfers between family members can avoid triggering a reassessment under Propositions 58, 193, and now 19. Missing these exemptions can result in dramatically higher property taxes.
Mistake #4: Not consulting a tax professional familiar with California real estate
California’s tax landscape for homeowners is uniquely complex. A generic tax preparer might miss state-specific opportunities. I’ve built relationships with several tax professionals who specialize in California real estate matters and often refer my clients to them.
Planning for Future Tax Benefits
Smart tax planning for California homeowners doesn’t stop after purchase. Consider these ongoing strategies:
Strategic Timing of Property Tax Payments
Because of the SALT cap limitations, some homeowners benefit from “bunching” property tax payments—paying two years’ worth of property taxes in a single year to maximize itemized deductions, then taking the standard deduction the following year.
Home Equity Loan Interest
Interest on home equity loans or lines of credit is deductible only if the funds are used to buy, build, or substantially improve the home that secures the loan. This is a change from pre-2018 rules, when the use of funds didn’t matter.
I had clients in Culver City who were planning to use a HELOC for their daughter’s college tuition. We had a conversation about how this would affect their tax situation, and they ultimately decided on a different financing approach since the interest wouldn’t be deductible.
My Personal Advice After 20+ Years in California Real Estate
After helping hundreds of California homebuyers navigate their new tax situations since 2003, here’s what I tell all my clients:
- Consult a tax professional before making major real estate decisions. The consultation fee is minimal compared to potential tax savings.
- Don’t buy a home just for the tax benefits. They’re nice, but they rarely justify a purchase that otherwise doesn’t make sense for your lifestyle and finances.
- Keep immaculate records. California’s high property values mean even small percentage savings translate to significant dollar amounts.
- Revisit your tax strategy annually. Tax laws change, and your personal situation evolves.
- Consider the long-term tax picture. California’s Proposition 13 protection becomes increasingly valuable the longer you own your home.
I remember sitting down with a young couple who bought their first home in Highland Park about five years ago. They were so focused on just making the monthly payment work that they hadn’t considered the tax implications at all. We spent an hour reviewing potential deductions, and they ended up saving over $4,000 on their taxes that first year—money they used to replace the ancient water heater that was on its last legs!
Between you and me, navigating California’s real estate tax landscape can be as challenging as finding an affordable home in a good school district! But understanding these deductions and credits isn’t just about saving money—it’s about making informed decisions that support your long-term financial wellbeing in one of the nation’s most expensive housing markets.
Remember, while the upfront cost of California homeownership might cause initial sticker shock, these tax benefits help make the long-term financial picture significantly brighter. Just make sure you’re claiming everything you’re entitled to!
