Real Estate 101

Home Ownership Tax Benefits

posted by Matt March 1, 2017 0 comments

The benefits of owning your home tend to be pretty obvious. Pride of ownership, investment in equity, and of course nobody can tell you that you can’t have pets. But when it comes to taxes, the benefits can be a lot less obvious. And if you don’t know about them, you might not even know enough to take advantage. Yet some of the most tangible benefits of home ownership directly relate to lowered taxes. So it’s not a bad idea to know what benefits you could be claiming.

Imputed Rental Income

OK, this is the trickiest one, and it’s not all that easy to explain, so stick with me here for a minute.

Let’s say you own a home, and your friend owns a home, and you both pay the exact same amount for your mortgage (never mind that this is statistically unlikely – it’s an example). Now say you switch houses, and pay each other rent. You pay the exact amount of rent that you need to cover your mortgage, and you use that rent for that exact purpose. Paying the mortgage on the home you own but don’t live in. In this unlikely and complicated example, the amount you receive for renting your home to your friend is now taxable income.

So now swap back. Instead of paying rent and using the rent on your house to pay your mortgage, just cut out the middle-man and pay your mortgage. You’re effectively still getting the rent, right? It’s just that you’re paying it to yourself instead of your friend, even if it winds up in at the bank, to pay your mortgage. But there’s no rent check, so there’s no taxable income. And that’s where you’re getting a pretty huge tax break. It might seem like a technicality, but it’s actually called imputed rental income. And tax law specifically says you don’t have to pay taxes on it.

This might not seem like a big deal if you don’t think about it too hard. I mean, you don’t have to pay an income tax on the rent you might pay an apartment, right? That would be nuts, because it’s not an income. But the apartment complex owns your home in this case. And they do have to pay taxes on your rent money because for them it’s income. Simply, because they own the joint.

Or let me make it a little simpler. Owning a home means you get out of a bunch of taxes. And you don’t even have to do anything to get the benefit.

Mortgage Interest Deductions

Let’s start with the basics. When you make any kind of income, the expenses directly related to earning that income are deductible.

For instance, if you run a business making wooden birdhouses, you can deduct the wood, nails, glue and paint you buy to make them. If you run a restaurant, you can deduct the food. And if you earn imputed rental income (because you live in your own home), you can deduct the interest you pay on your mortgage. Why? Because it is an expense related to earning that income.

You can deduct the interest you pay on your mortgage from your federal tax return. You do have to itemize your taxes to get this benefit – no more 1040EZ for you. Downside – your taxes are more work. Upside – you pay less in taxes. Keep in mind that this isn’t a blanket rule. If you live in a very inexpensive home or own your home outright, you might be better off using the standard deduction.

Talk to a CPA. Don’t take my word for it.

Property Tax Deduction

If you haven’t ever owned a home, you may be about to learn about a new thing. Property taxes.  When you own a home, you’re going to pay your local municipality some taxes just for owning the place. Those taxes pay for stuff like schools and roads and street lights, and for many cities they are one of the main sources of income.

You can’t get out of those property taxes. But they’re probably rolled into your mortgage payment in an escrow account, so you don’t actually see them. They do mean you have a higher mortgage payment. And don’t always realize that only half of your check every month goes to pay for your home. But you’ll get a statement at tax time telling you how much you paid for property taxes, and you can write that off on your federal income tax return.

OK, this doesn’t feel like much of a benefit. I mean, you wouldn’t pay those taxes in the first place if you were renting, right? But here’s the thing – if you own your home and don’t deduct your property taxes, it means you’re paying them twice. So this isn’t so much a benefit of owning a home as it is a thing that you should know so that you save money on your taxes. And since that’s why I’m writing this one – to tell you how to save money on your taxes if you own a home – I’m bringing it up.

Capital Gains Exemption

This is a big one, but it’s not likely to matter to you for a while if you just bought your home. Still, it’s worth knowing about, so I’m going to mention it.

If you sell that birdhouse I mentioned earlier, and you clear ten bucks after you pay for your wood and glue and all your other expenses, you owe taxes on that ten bucks. That’s how income tax works. If you get income from a paycheck, you owe taxes on that income. But if you get income from selling your primary residence, you can keep a bunch of it.

I’m going to reiterate at this point that I am not an accountant, and if you sold a home and want to know how much you need to pay in taxes, talk to a CPA. But I do know enough to tell you this – if you have lived in your home for the last few years, and you sell it, you can shelter up to $250,000 from taxes.

Another hypothetical? Why not. Let’s say you buy a home for $150,000. You live in it for ten years, take good care of the place and sell it for $200,000. In the meantime, you also paid down your mortgage a fair bit, so let’s say your loan was only $100,000 when you sold. That means you’re going to clear a cool hundred grand on this sale, and Uncle Sam isn’t going to ask you for any of it. That is a pretty big tax saving right there, and it makes buying a home one heck of a good investment.

You won’t be able to take advantage of the capital gains tax incentive until you sell your home, but it’s a good reason to think about buying a home.

Homestead Exemptions and Other Savings

Every state has different stuff that might also help with your taxes. Texas, for instance, has homestead exemptions that will lower your taxes if you live in your house. Other states have other programs, but I don’t live in those states so if you do, ask your tax pro about them. If you don’t have a tax pro, do a little research on the tax laws and benefits of home ownership in your area. It could save you thousands of dollars a year.

Once again for the people in the back, I’m no tax expert, so definitely consult a CPA who is more familiar with your specific circumstances when determining what tax benefits might apply to you. 

You may also like