We all know the reasons for owning a home: it’s a place you can decorate and fix up the way you want it (inside, anyway) without anyone’s permission, and no landlord can tell you he doesn’t want you hanging up that beer sign or that fuchsia walls are out of the question. The feeling of walking into a place where no one else is allowed to come into without your permission is pretty powerful. Owning a home often gives people a feeling of power over their own destinies and a sense of financial security. Some even say that they didn’t feel like an actual adult until they signed those papers and got handed that key. I believe people are calling that “adulting” these days.
All these emotional reasons are important, no doubt, but owning a home definitely has financial benefits as well. For instance, you’re no longer giving money away to the owner of a place for the privilege of unpacking your Tupperware there. You’re no longer paying your landlord’s mortgage! You’re no longer at the whim of an absentee landlord. Best of all, you’ve made the biggest financial investment in your future that you’re likely ever to make and building equity in an asset that is relatively low risk and high return. Plus you get to live there!
One of the biggest financial benefits of owning a home is reducing your income tax liability. In these tough economic times, it’s nice to have a buffer between you and a growing tax burden. Mortgage interest, home equity loan interest and sometimes mortgage insurance premiums are tax deductible. What specifically does this mean? It means that paying real estate interest and insurance lowers your tax liability by lowering your taxable income.
Also, the profit you make when selling a home is tax free up to $250,000 if you’re single and $500,000 if you’re married and file taxes jointly. Amounts over those limits are taxable as capital gains, currently at 15 percent, but that’s another article. See information about the 1031 Exchange and Self-Directed IRAs in other areas of this site.
To spell it out further, here’s an example of how your taxes are affected by owning a home:
Kawika is a single guy with no children who rents a condo for $1200 a month. His adjusted gross annual income is $128,000. He has $3500 state income tax withheld from his paychecks during the year and qualifies for no itemized deductions. His federal income tax liability for the year:
Adjusted gross income: $128,000
Standard deduction: single $4400
Personal exemption $2800
Taxable income $120,800
Kawika’s federal income tax as a renter: $32,129.
But if Kawika buys a condo with a mortgage payment of $1200 per month, everything changes:
Adjusted gross income $128,000
Itemized deduction for state income taxes: $3500
Itemized deduction for real estate taxes: $1500
Itemized deduction for mortgage interest: $11,400
Personal exemption $2800
taxable income: $108,800
Kawika’s federal income tax as an owner: $28,409.
Kawika just saved nearly $4000 by buying a condo instead of paying rent! The $4000 savings covers 3 months of mortgage payments or nearly funds his Roth IRA for the year! If Kawika is a W-2 employee and gets a refund each year, he can use the W-4 form to change his federal tax withholding and put a portion of that $4000 in his pocket each month instead of waiting for the refund when he files his taxes next year. It’s important for Kawika to consult with his tax consultant (CPA) or financial planner to determine the best use for the tax savings.
There’s only a month to tax filing deadline on April 15th and it’s too late to take advantage of the tax benefits for this year. However, you can still buy a home this year and reap the tax benefits for a partial year on your 2019 tax returns and the full benefit for many years to come. Please feel free to reach out if you’d like to discuss tax benefits for home owners or investors, or if you’d like to get started on the tax savings plan of home ownership.