Home is a Key Tax Advantage

Tax advantages owning a home is keyProspective buyers struggling to make their $1,500 monthly rent payments often ask, “How in the world can I make a $2,000 mortgage payment?”  Here’s how…

Richard J. Venegas, an Escondido certified public accountant, doesn’t accept new clients unless they are homeowners.  His job is to help people save on their taxes. “If someone doesn’t have a house,” he says, “I just can’t help.”

Owning a home not only offers numerous tax advantages, it often permits taxpayers to take advantage of other tax breaks, too. Venegas, who is also a certified financial planner, calls home ownership “the gateway to itemized deductions.”

It’s that and more, says John M. Smith, a certified financial planner and co-owner of Mission Mortgage in Mission Gorge, who works with first-time buyers.  I advise my clients that the purchase of a home is the first, most important step in a secure financial future,” he says. “The basis for family wealth is the family home. That is the first investment you should be making.”\

What helps make the American home a source of wealth are several different and often lucrative tax breaks, from the moment of purchase to the date of sale:

Buying a home. Entering the housing market where a starter home costs more than $200,000 can be challenge. But the sizable tax breaks from home ownership can make a purchase possible. The tax code allows homeowners to deduct the interest on their mortgage payments and also their property tax.

Smith offers this example, assuming a typical San Diego home price of $280,000, with 10 percent down, a $252,000, 30-year, fixed- rate loan of 7 percent, and a mortgage payment of $2,089 a month. He often sees prospective buyers who are struggling to make their $1,500 monthly rent payments. They ask, How in the world can I pay $2,000 a month?” Here’s how.

For a married couple who earn $75,000 annually and pay $13,653 in federal and state taxes, buying the home would reduce their income taxes to $8,387, for savings worth $439 per month. For a single taxpayer making $75,000, and paying $19,865 in combined taxes, the purchase would reduce taxes to $12,870, for a savings of $582 per month. If your home-purchase loan has points, or 1 or 2 percentage points of interest paid upfront, you are allowed to deduct the entire amount the year you buy. (However, when you refinance, you can only deduct points by amortizing them over the life of the loan. Should you refinance again, though, you can deduct the entire balance of the points from the first refinancing in one year — but you must amortize the points on the new loan.)

One note of caution: In their eagerness to have Uncle Sam help them with their house payments, some taxpayers overestimate the amount of tax savings they’ll get in the first year and are too aggressive in changing their tax withholding. This tends to happen more often when homes are purchased in the later part of the year and thus the first year’s tax benefits are lower than in following years.

Borrowing against your home. Not only can you deduct the interest on the mortgage you take out to buy your home, the tax code also allows you to write off interest on other loans against your property — in certain instances. You can deduct the interest on a first mortgage of up to $1 million. Beyond your first mortgage, you can write off the interest on a home equity loan of up to $100,000, and use the proceeds however you like, to buy a car or start a business. In addition to your first mortgage and your equity loan, you can also take the interest deduction on loans of theoretically any size against the house that are used to improve the property.

Getting a tax-favored loan is certainly a good deal compared with other loans. Smith says the most popular are the prime-rate home equity line of credit, which charge 4.75 percent interest-only for 10 years, then must be repaid. That’s an after-tax cost of borrowing of 3.2 percent, for a homeowner in the 33 percent combined tax bracket.  But the low rates could come back to haunt today’s borrowers, says Smith, who advises clients to repay the loans aggressively: “Today’s low short-term borrowing costs are very attractive compared with other rates, but beware, they will not stay low forever.”  And they can be too much of a good thing for consumers with a habit of racking up credit card debt. Venegas advises, “You want to make sure you do this only once.

Selling your home. Thanks to tax rules that were greatly liberalized in 1997, most taxpayers who sell their homes can pocket the appreciation tax-free.  A married couple who used their home as their principal residence for two of the five years prior to selling can take up to $500,000 profit without paying capital gains tax. For single taxpayers, the limit is $250,000.   “Tax-free income is almost impossible to get,” notes Venegas. “And this is one way to get it legally.”  The exclusion can be so substantial, says John W. Roth, federal tax analyst for the tax publishing firm CCH, that the “profitable sale of a longtime family residence is often one key to financing retirement.” Under the rules, your principal residence can be a houseboat or a recreational vehicle. The period of residency doesn’t have to be continuous, so occupying a house in the first and fourth year of a five-year period would qualify. Homeowners can take the exemption on their residences, then move into their rental or vacation homes and repeat the process in two years.  Widows and widowers can claim the full $500,000 exemption rather than the $250,000 for single persons if they sell in the same year that their spouses died.  The law does offer some hardship exemptions to the two-year rule. For example, if a homeowner spent just one year in his home before entering a nursing home, he could count the time in the facility toward the two years.  If you need to move more than 50 miles from your home because of work, you can pro-rate your exclusion. For example, if you move after one year and you have a $100,000 gain, $50,000 of that would be tax-free.  There are almost no tax downsides to owning a home, says CCH, except that big property tax deductions can sometimes trigger the alternative minimum tax.  And, says Smith, there are important non-monetary benefits: There’s a sense that owning your own home gives you some control over your own life.”

By Ann Perry SD Union Tribune 3/27/2002