Ahhh… the American Dream. Home ownership is a key element in the pursuit of the American Dream. It gives us stability, a place to plant our roots and be a part of a community. It’s also an investment. Paying a mortgage builds equity; paying rent just gives you a place to live for another month. But does buying a home help with taxes? Can buying a home actually improve your personal income tax situation? Like most tax-related topics, the question involves more than a yes, or no answer.
Standard vs Itemized Deductions
You first have to determine whether you will be taking the standard deduction or itemizing your deductions. “Deductions can reduce the amount of your income before you calculate the tax you owe.” irs.gov. Thus, reducing the amount of money you pay taxes on which results in a lower tax bill.
The IRS has decided the standard deduction for the filing year 2021 is simply $12,550 for individuals, or $25,100 if you’re married filing jointly. This is a given, everyone who files can take this deduction.
The other option would be to itemize your deductions. This way is a little bit more involved, but worth the hassle if these deductions add up to more than what you would get if you were to take the standard deduction. This is an either/or situation. You cannot take the standard deduction and also claim the itemized deductions.
There are several types of itemized deductions, and as always, we suggest talking to a CPA for guidance, but these are the 3 main line items on personal tax returns to consider.
- State and local income, sales and personal property taxes. The cap on these is $10,000 combined, so even if you spend $24,000 in combined income, sales and personal property taxes, you can still only deduct $10,000.
- Charitable contributions. These contributions need to be made to an eligible non-profit organization. Eligible organizations include those that are designed to prevent cruelty to animals or children, or religious organizations. In my church we give 10% of our income as tithing. That would be an eligible contribution. There are a few more types of eligible contributions, but to be clear, making brownies for a friend that just got dumped by her boyfriend, or giving money to the neighbor boy for baseball camp are not considered eligible contributions. Check with your CPA if you are unsure.
- Mortgage interest. Each year you should be receiving a form from your lender that details the exact amount of deductible interest you’ve paid. Home equity loans are also deductible as long as the loan was used to buy or improve the home the loan is on.
As an example, if you purchased a home for $350,000 last year at an interest rate of about 5-6% your mortgage interest would likely be around $22,000-$26,000. So your interest plus the state and property taxes and charitable contributions would add up to make the home purchase worth it for the sake of lowering your tax bill.
What does all this mean?
The first thing we realize with the example above is that you would choose to itemize your deductions rather than take the standard deduction.
Why? Because the standard deduction for a married couple filing a joint return would lower your taxable income by $25,100.
On the other hand, itemizing state, local and personal property tax + charitable contributions + your mortgage interest = more than $25,100. That’s what we want. We want to lower your taxable income as much as possible to reduce the amount owed on your tax return.
Secondly, it means that in this example, buying a home could help your tax situation. Your wealth grows each year as you increase the equity in your home; and you lower your taxable income when you itemize your mortgage interest and charitable contributions.
Does buying a home help with taxes? Yes, it certainly can.
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