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Real Estate: Tax Follies
Owning a home is the greatest investment you can every make. Right? While there is no doubt that there are a lot of fabulous reasons for owning a home, the massive tax breaks may not be all that they are cracked up to be. The reason? Taxes are a percentage game.
Many people assume that if you pay $1,000 in home mortgage interest, you’ll end up reducing your tax bill by the same amount. If you’re like most Americans, you are a taxpayer and are in the 25% marginal tax bracket, so a $1000 in mortgage interest paid actually reduces your taxes by only $250…perhaps. Why perhaps? Well that’s because of a little thing known as the standard deduction. All taxpayers receive the benefit of the standard deduction regardless of whether or not they are homeowners or not. As a taxpayer, you can deduct from your taxable income the higher of your standard deduction or your itemized expenses. Another way of saying this is that your itemized deductions reduce your taxable income only when they exceed your standard deduction. This year, the standard deduction for single people is $4,850 and for married taxpayers is $9,700.
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So if you just moved from an apartment to a home and hope that the tax savings may help bail out your finances, you may be mistaken. If you were paying $800 in rent and decided that you could afford $850 in mortgage payments for, say a $175,000 house, you might want to sharpen your pencil again. On a $175,000 house with $35,000 down you will probably end up paying some $8,000 per year in interest on your mortgage. If you throw in taxes of $2,500 a year, your itemized deduction would be $10,500 per year. Sounds good, but if you’ve had also to take out private mortgage insurance (which is not tax deductible) your finances might be becoming a little strained. As a single person, buying a home would result in your having itemized deductions that exceed your standard deduction by $5,650 but if you’re married it would only be a meager $800. The net tax benefit of homeownership in this case: $1,412 benefit as a single and a paltry $200 benefit as a married couple. Add in the costs of maintenance and repairs and you might be a whole lot better off staying put in your apartment.
Of course, if you can afford a whole lot more house than the average person, then all this talk about the standard deduction becomes a little less relevant. If your dream house is valued in the millions as opposed to the mere hundreds of thousands, then your mortgage will increase along with the purchase price and your deduction will keep pace as well. As your mortgage interest increases your deduction will become larger and you will soon be looking at a pretty large itemized deduction. Listen, if you can afford the big price tag of a luxury home, then little things like the standard deduction won’t matter a whole heck of a lot.
But for the rest of us, they do. Of course there’s a number of reasons to buy a home - tax breaks just might not be one of them. There the pride of ownership and the sense of total freedom that comes with owning your own home are among the better reasons for owning a home. As well, home ownership represents a forced savings plan for some people. While tax breaks can be a benefit of owning a home, that isn’t always the case and you should consider home ownership from all sides before you sign on the dotted line.
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