Tax Benefits of Buying a House

Have you ever had someone tell you that you need to own your own home. Maybe it was your parents, grandparents, or financial adviser that came to you and said that you are losing out by not buying. Well, they are probably right.
Of course, there are both pros and cons to home-ownership. When it comes to filing your taxes, however, you will most likely save a ton of money by owning your home both through tax deductions, and deferred or exempt capital gains.

Tax Deductions

There are a few ways that owning your own home will help you out at tax time, and the first ones are all itemized deductions.

Deducting Your Interest

All of the interest you pay on the mortgage for your primary residence is entirely tax deductible as long as your loan amount is within a certain limit. For loan amounts above the limit the interest deduction starts to phase out.

Loan amount limits:

Married Couple – $1 million
Single Filer – $500,000

When you buy your home your monthly mortgage payment is made up of principle, interest, taxes, homeowners insurance, and usually [private mortgage insurance (PMI). But, you might be surprised to learn that the proportional amount you pay in principle and interest actually changes from month to month over the life of your loan.

In the beginning of your loan, the principle & interest portion is actually much more interest than principle. But, by the end of your loan this ratio will have slid over to the other end of the scale, and you will be paying much more in principle than interest.
So, this interest deduction will actually benefit you much more in the beginning of the life of your loan. But as the years go by and you start paying less in interest and more in principle, you may not be getting the same tax deduction but at least you will be paying off your loan faster!

Deducting Your PMI

PMI, or Private Mortgage Insurance, is also tax deductible but there are some restrictions. First, PMI is only deductible on loans taken out or refinanced after January 1, 2007. Also, this deduction unfortunately expired at the end of 2016 and we don’t know yet whether congress will extend it in 2017 or not.

There are also income restrictions on PMI deductions too. A married couple can only deduct 100% of their PMI if they make less than $100,000. The deduction then quickly decreases until it is completely phased out at $109,000. These limits are $50,000 and $54,500, respectively, for single filers.

Deducting Your Property Taxes

Once you buy a house there will be an annual property tax associated with it. Nobody likes to pay taxes, but unfortunately this one is just a fact of life. The good news is that this is another write-off for you if you own your home.

These taxes are paid twice per year. When you get a mortgage you can decide whether or not you want to set up an impound account that pays your taxes for you and just adds them to your monthly bill. Most people choose to, and I usually recommend it. Just keep in mind that if you decide to pay them yourself then you will need to track down an additional document to get this write-off at tax time.

Of course, there are also income restrictions on the property tax deduction. For married couples the income limit is $300,000, and it’s $250,000 for single filers. The way this limit works is that your tax deduction is reduced by 3% of whatever amount you earn over the limit.

Here’s an example:

If you are married and your household income is $400,000, then you would start by subtracting the $300,000 limit from your income: $400,000 – $300,000 = $100,000. So the amount that your deduction would be reduced by is $3,000 (3% of $100,000). If you paid $5,000 in property taxes, then you would deduct $2,000 ($5,000 – $3,000) on your income taxes.

Tax-free Capital Gains.

When most people think about the benefits of owning a home, they usually think of the appreciation in value that they will see over time. Like most investments, a home’s value will go up and down throughout the years but will generally trend upward in the long-run.
When you sell your primary residence, any appreciation in value, or Capital Gains as the IRS refers to it, is completely tax-free up to $500,000. In order to qualify as a primary residence you need to have lived in the home for at least 2 of the last 5 years.

How to Reap all the Tax Benefits of Buying Your House.

At the end of each year you will receive a 1098 Mortgage statement from your loan servicer. This is the form you that shows how much interest and PMI you paid that year. If you impounded your taxes through escrow than this form will show your taxes paid as well. This is the form you use to claim all of your deductions.

Save Money EVEN if Your Mortgage is More Than Rent

So let’s take a look at how buying a house will save someone money over renting EVEN IF the monthly mortgage payment is higher than the alternative rent.

EXAMPLE 1

John and Jill McPrudent make $100K per year. They take the standard deduction for a married couple of $12,600. They pay $13,392 in taxes and takes home $86,608.

Now let’s assume that the market rent in his area is $2,800 per month for a total of $33,600 for the year.
After paying the McPrudents now have $53,008K left over for the year.

EXAMPLE 2

Now Let’s say John and Jill McPrudent bought a house and borrowed $445K. The monthly payments including principle, interest, taxes, PMI, and insurance is $2,980, which is $180 ($2,160 per year) more than their rent was.

The amount paid in interest for the first year is $16,547, property taxes are $5,760, and PMI is $3,782.50 for a total deduction of $26,089.50

So after this deduction John’s taxable income is $73,910. He pays $10,159 in taxes and takes home $89,841. The total amount in mortgage payments for the year is $35,760.

After his deductions and mortgage payments John has $54,081 left over for the year, which is $1,073 more than he had left over when he was paying $2,160 less per year in rent.

Standard Deduction vs. Itemized Deductions

The above scenario works out because the itemized deductions were higher than the standard deduction. You can only use one, so if the only reason you want to buy a house is to save money on taxes… Then you will need to run this calculation to make sure that it works for you and your situation.

For example, if the McPrudents bought a less expensive house they might not have had enough deductions to make up for the standard deduction that they gave up.

CONCLUSION

Even when John McPrudent pays $180 MORE every month, he ends up with an extra $1,073 in the bank at the end of the year. Not only does he save $80 as a result of paying less in taxes, but when the house appreciates in value he gets to keep that money as well. Tax Free!