When you own a home, you can deduct the mortgage interest and a few related costs from your taxable income by itemizing your deductions on Schedule A of Form 1040.

By the end of January each year, your lender will send you a Form 1098 showing the amount of mortgage interest you paid during that year. Points you paid at closing are deductible the first year you own your home if they're considered a prepayment of interest and meet a number of other requirements. You might even get a deduction for points that a seller pays for you, if you can negotiate that type of concession. For a complete list of the requirements, see IRS Publication 936, Home Mortgage Interest Deduction. If your points don't meet these requirements, you can deduct them over the life of the loan. Most of the other costs paid at closing are not tax-deductible.

Real-Estate Property Tax Deduction

You can also deduct real-estate property taxes from your taxable income. If property taxes are included in your mortgage payment and paid by your lender, claim the amount the lender actually paid out during the year, not the amounts included for taxes in your monthly mortgage payments. Your lender places these funds in an escrow account for safekeeping and uses the funds to pay your real estate and insurance.

If your local real-estate taxes include charges for services such as trash removal or water and sewer, this portion of your taxes is not deductible. Look carefully at your copy of the real-estate tax bill to determine how much you can deduct. The bill should identify services separately from taxes, which are based on the value of your property.

Calculating Your Tax Savings

To calculate how much you'll save by deducting mortgage interest and property taxes, you need to know your marginal tax rate for federal and state income taxes. You can get these rates from the tax rate schedules in your tax return packets or from the IRS Web site (www.irs.gov). In 2007, a married couple filing jointly with income of $110,000 had an average tax rate of 18.5 percent. We'll assume a state tax rate of 6 percent, for a total of 24 percent. Multiply this rate times the amount you can claim on your income tax return for mortgage interest and property taxes to get the amount you save in income taxes. If you were married with a 26 percent combined tax rate and $10,000 in deductions, you'd save $2,600 in taxes ($10,000 × 0.26 = $2,600), a monthly savings of $217. If your mortgage is $1,000 a month, your actual after-tax cost is $783 ($1,000 – $217 = $783). This is a significant tax savings, but remember that there are other costs associated with owning a home that you don't incur when renting.

Moreover, you may save more than this example if owning a home allows you to itemize for the first time. When you itemize, you can also deduct state income taxes, charitable gifts, and medical and dental expenses that exceed 7.5 percent of your income. You can file a new W-4 to claim more exemptions and have less tax taken out each week or leave your withholding as it is and get an income tax refund at the end of the year.

Keep in mind that the tax savings are complex. It may be that you won't save much at all if the numbers on your return don't all work together the right way. Therefore, any tax savings should just be considered a bonus — not a reason — when considering home ownership.