By Mike Nelson
Coldwell Banker Danforth Associates
In the past five years, the “American Dream” of homeownership was shaken pretty hard. But through it all, owning your own home still rises to the top of the list for a person’s security and wealth. Tax savings is a big reason to pursue that dream.
Purchasing a home is typically the largest purchase and among the most important financial decision a family makes. There are numerous factors that influence the home buying decision, and among the most important are the tax benefits that help offset some of the cost of homeownership. This article examines how these tax benefits reduce the cost of homeownership for individual homeowners and homebuyers for certain mortgage amounts and income levels.
For example, a household with $80,000 in annual income that obtains a $200,000 mortgage will save on average $1,765 in the first year of homeownership. By the end of the fifth year of homeownership, the household will save on average $8,607 on taxes, and this amount grows to $19,488 by the end of the average period ownership, 12 years. This homeowner can expect to save $21,650 in capital gains taxation, yielding a total benefit of $41,138 over the expected period of homeownership.
There are three major tax benefits for homeowners: deductibility of mortgage interest, deductibility of real estate taxes, and the capital gain tax exclusion for principal residences. Taken together, these benefits significantly reduce the cost of homeownership. Each represents a significant provision of law.
According to the Congressional Joint Committee on Taxation, for fiscal year 2008 the tax expenditure (approximately the size of the program in terms of tax savings) of the mortgage interest deduction totalled $67 billion, the real estate tax deduction $24.6 billion, and the capital gain exclusion $16.8 billion.
As seen in these estimates, the largest benefit for most homebuyers is the ability to deduct home mortgage interest. The tax code permits homeowners who itemize their federal income tax deductions to reduce their taxable income by the annual amount of mortgage interest paid on a first (and second) home, up to $1 million in total home mortgage debt. Further, taxpayers may deduct interest allocable to up to $100,000 of home equity loans. Itemizing homeowners may also deduct state and local real estate taxes paid on an owner-occupied home.
Finally, taxpayers may exclude from capital gains taxation the proceeds from the sale of a principal residence. Taxpayers are limited in the amount of gains that may be excluded from tax: $500,000 of gain for married homeowners and $250,000 for single homeowners. Recent changes in tax law reduce these maximum exclusion amounts proportionally for the amount of time the home is actually used as a principal residence. Periods of ownership prior to Jan. 1, 2009 are treated as periods of principal residence use under a grandfathering rule included in the law.
— Mike Nelson is sales and marketing director of Coldwell Banker Danforth Associates in Poulsbo.