Who doesn’t dread tax time? But buying a house could possibly ease that pain slightly because the government still gives some good incentives when it comes to tax benefits.
“If you are comparing apples to apples, then buying a house can be one of the biggest benefits for individual taxpayers,” says Jeff Upchurch, CPA and owner of Upchurch & Associates in Chicago. “For tax purposes with all things equal, if you can afford it and you can be happy, there is no tax reason not to buy a house. There are some really nice tax benefits to doing it.”
According to the IRS Publication 530, to deduct expenses of owning a home, you must file Form 1040 and itemize your deductions on a Schedule A. If you itemize, you cannot take the standard deduction of $12,200 for a couple filing jointly or $6,100 for an individual. Upchurch says most people don’t itemize their deductions unless they have a mortgage.
Two of the biggest benefits you can get with a house are deducting the interest you pay on your mortgage and your real estate taxes.
For example, if you have a $300,000 mortgage with a 5 percent loan for 30 years, you could deduct the $15,000 you are paying in interest. Plus, you get to deduct the real estate taxes that you paid for that year.
But Upchurch wants people to know that it isn’t an exact reduction in taxes. People misunderstand that concept.
“It’s not quite one to one. The deduction reduces your income so that your taxable income is lower,” he says.
The mortgage company is required by the IRS to send a statement at the end of each year on how much interest and principal you paid on that mortgage. In the beginning of your mortgage, you pay mostly interest. But as you start to get into more years of the loan, you begin to pay more of the principal each month and the interest amount goes down – meaning you will have less to deduct.
Joseph Clemens, certified financial planner and co-founder and owner of Wisdom Wealth Strategies in Denver, likes to be the pragmatist when it comes to the hype about tax benefits of buying a house.
“Sometimes, this can be generally overrated,” says Joseph Clemens, “It is a subsidy. It’s from the government. It’s no different than when we go out and buy a phone. We get a subsidy. We get a $300 phone for a lot less, but we have to sign up for a 2-year contract. Whenever you are taking a subsidy, you shouldn’t make the purchase just because of the subsidy.”
He explains that was part of the problem that the real estate and mortgage crisis happened in 2008. People were getting in homes too big and too expensive.
“They bought more than they should because they were factoring in their tax benefits,” he says.
But if potential home buyers take some time to estimate what their tax benefits would be with their financial planner or accountant, then they might come out ahead. For instance, Clemens uses an example while teaching at College of Financial Planning in Denver.
It’s a straight forward case scenario. John and Jane Smith pay $1,000 a month in mortgage interest. They make $125,000 as a couple. Clemens throws in that they pay $2,500 in real estate taxes – which is deductible, too.
“Their federal tax break would be about $1,775. The government is writing you a check for $1,775 that you can do with what you want,” he says.
But there are two sides to every coin.
“It is always presented that tax benefits are so good for homeownership. Real estate people use it as a part of their pitch. But it might not always be good. It’s a case by case situation,” he says. “People are living paycheck to paycheck. Most Americans don’t have enough liquid savings.”
A few other smaller tax deductions that the IRS includes when you buy a house include: the cost of points paid at closing; mortgage insurance premiums; penalty-free IRA payouts for first-time buyers; energy credits (when available); tax-free profit on sale of the house; and home improvements.
“If you are making improvements on your house, it becomes another fantastic tax rule,” says Upchurch.
When you sell your personal residence, your first $250,000 isn’t taxable. If you are married, it’s twice that amount.
“Even people who have had a home for decades can see a big tax benefit,” he says. “If you sold your home for $600,000 more than you bought it in the 1960s but you put $150,000 improvements over the years, you still would have $450,000 that isn’t taxable for a married couple,” he says.
He says you just have to keep track of all your receipts in case you ever get audited.
“It’s just so much easier to put a receipt in a file until you need, instead of having to go back to someone and ask for a receipt from 1974,” he says.
No one knows when Congress will vote against the mortgage deduction in the near future, Upchurch says. “I don’t think they would take away these deductions without some kind of tax break that would be equal to it,” he says.
The American Taxpayer Relief Act of 2012 addressed some of the fiscal issues facing homeowners.
According to the website of the Massachusetts Society of CPAs, “The final negotiations in Congress at the end of last year answered several important questions, including whether home owners would continue to be allowed to deduct mortgage interest from their taxable income. The new law does not eliminate that deduction, and that’s a positive development for home owners because their tax bite could have expanded significantly otherwise.”
But Clemens warns you to just check out how much benefit you would be getting tax-wise and if you can afford what you are buying.
As we are not tax advisors, remember to always consult a tax consultant and financial planner before making any financial decisions or commitments.