The Tax Benefits of Home Ownership
by Bob Mangold
Everyone knows that owning a home is the American dream, but did you know that borrowing to pay for one is a taxpayer's dream? Home mortgage interest is deductible on your income taxes if you itemize.
You can deduct the interest on up to one million dollars of home mortgage debt, whether it is used to purchase a first or a second home. You can also deduct the interest on up to $100,000 of home equity debt, even if you don't use the money for home improvements.
Real estate taxes are deductible as well. With the availability of these tax deductions, you should consider whether borrowing on a home is right for you.
Consider newlyweds Michelle and Ryan Shelley are struggling to cover close to $3,000 in monthly expenses on their new $405,000 house in Scottsdale--more than twice what they paid in rent on an apartment. But the couple is getting help from their uncle. UNCLE SAM, that is.
Federal tax deductions for the payment of home mortgage interest and real-estate tax will save about $6,288 in tax this year for the Shelleys, equal to a $524-a-month cut in their housing cost. (Those deductions will also save about $2,033 in state income tax.)
"Every time we make a payment, we know we will get some of it back from the government," says Ryan, 25, a Web developer. Michelle, also 25, is a forensics expert in the sheriff's department. Without the house, the couple would have claimed a $9,700 fixed-amount standard deduction when filing their tax return. Now, they can claim a higher amount by itemizing tax-deductible spending.
"Homeownership is substantially subsidized by the tax system," says Gerald Robinson, an attorney and author of Homeowner's Tax Breaks . "These are immense incentives a renter doesn't get."
An even bigger bonus comes when you sell a house. Up to $250,000 of profit can permanently escape income tax, $500,000 for a couple. You can use the exemption time and again as you shift residences, but you must generally live in one place at least two years. For some people, the exemption is an incentive to cash in on a tax-free sale when their untapped gain hits the cap. But overshooting the cap may not be a big deal, assuming no future tax boost. The excess now typically faces a capital-gains tax of only 15 percent.
As sacred as the tax breaks can be, they aren't unlimited. Home buyers can deduct interest on no more than $1 million of mortgage debt. Interest can be deducted on home-equity loans that let you borrow against a home's value, but only on loans up to $100,000. Higher-income people may face limits on their deductions, and the alternative minimum tax may bite.
What could the home mortgage deduction mean to you? What follows is an example of the potential tax savings for a potential home buyer.
Example 1
Bob rents a home at a cost of $1,200.00 per month. He is single with no children and takes the standard deduction on his income taxes. His adjusted gross income is $128,000. He has $3,500 in state income tax withheld from his paychecks throughout the year, but doesn't qualify for any other itemized deductions. Bob's federal income tax liability for 2008 will look something like this:
Adjusted gross income $128,000
less standard deduction, Single $4,400
less personal exemption $2,800
Taxable income $120,800
Bob's 2008 federal income tax $32,129
However, if Bob purchases a home with a monthly mortgage payment of $1,200, his tax liability is lowered.
At the end of the year Bob will receive a form 1098 from his mortgage company that shows how much of his mortgage payments for the year went to mortgage interest.
Bob's 1098 for the year 2008 shows that he paid $11,400 in mortgage interest. Bob also paid $1,500 in real estate taxes on his home in 2008. Bob's federal income tax liability for 2008 will look something like this:
Adjusted gross income $128,000
less itemized deduction for state income taxes $3,500
less itemized deduction for real estate taxes $1,500
less itemized deduction for mortgage interest $11,400
less personal exemption $2,800
Taxable income $108,800
Bob's 2008 federal income tax $28,409
In this example Bob saves $3,720 in federal income taxes. In addition, his monthly housing cost stays the same and he owns his home, rather than renting.
Most importantly, if Bob would make changes to his Federal Withholding he would receive an extra $310 per month in cash flow that would help offset his NET mortgage payment:
Here is what this means;
Monthly Payment: $1200
Monthly Tax Savings: $310
Net Monthly Payment: $890
Good deal, Bob!
As you can see the TAX BENEFITS from owning a home is HUGE. I realize this information is very detailed and a little intimidating, but it is important to realize the tax savings of buying a home and how to take the savings on a monthly basis versus an annual payout.
This additional monthly cash flow goes a long way towards making home ownership more affordable for people.
I will help you navigate this process to insure you are able to capitalize on this IRS benefit.
Sincerely,
Bob Mangold
(602) 291-4362
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