How buying a house can lower your taxes

Posted by Jason Kauffman on February 7, 2017

It seems like there is always a steady stream of first time buyers looking to get information about buying their first home. They all have different reasons for wanting to buy a home – settling down and starting a family, tired of dealing with a landlord, want to start growing equity in a home that’s theirs – the list goes on and on.

The one thing that many people forget is that the US Government has a tax deduction policy that encourages homeownership. The policy allows homeowners to write off property taxes, mortgage interest, mortgage insurance, and in some cases mortgage closing costs.  The same section of the income tax return that lets you write off mortgage/property related costs (Schedule A – https://www.irs.gov/pub/irs-pdf/f1040sa.pdf) also lets you write off state income tax, potential unreimbursed employment related expenses, health care costs, charitable donations, tax preparation fees, and more.

Understanding how you can benefit from owning versus renting requires digging a little into the tax code and understanding how you currently pay taxes.

Most people that do not own will usually take the “Standard Deduction” on their tax return. This is a reduction to the income that you have to pay tax on.

Below is the “Standard Deduction” table that applies to most people:

Link labeled ‘IRS Publication – Standard Deduction’ linked to  https://www.irs.gov/publications/p17/ch20.html

Regardless of the category you fit into above, the corresponding Standard Deduction is on the right. When your income is reduced by the standard deduction you pay tax on the new reduced income amount.

When you are a homeowner that pays more in mortgage interest/property taxes/mortgage insurance/State Income Taxes/etc than the amount of the standard deduction, you would be allowed to itemize the allowable expenses and potentially reduce your tax liability.  Keep in mind there are very strict rules about what can be itemized and what can’t.

So now let’s do a brief example to show how owning versus renting can change your annual income tax owed

Example:

Joe pays $1500 per month in rent and is looking to buy a new home where his mortgage payment is about the same as his current rent. He buys a home and gets a $225,000 mortgage @ 4% interest. He also pays $1700 per year in property taxes and $160 per month in mortgage insurance.

New Monthly Payment: $1600

Yearly interest: $9000

Yearly property tax: $1700

Yearly Mortgage Ins: $1920


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Total: $12,620

Joe is single, so his current standard deduction is only $6300. Joe stands to reduce his taxable income by an additional $6320 by owning versus renting. This translates into about $1580 less in taxes paid to Uncle Sam (assumes 25% tax rate).

So at the end of the year our hypothetical homeowner Joe pays $1580 less in federal tax than he would have had he rented. In addition to that he would’ve paid down about $3900 in principal balance on his loan.  Also, as the market appreciates he will begin to grow equity in the home (the difference between the current loan balance and the value of the home).

Outside of the practical reasons you would want to buy your own home there are also some very sound financial incentives to be had. Be sure you take the time to consider the financial benefits of homeownership compared to renting. Reach out to your CPA for professional tax advice about the income tax implications of purchasing a home.

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