In an early episode of The Hitch Hiker’s Guide to the Galaxy, a character named Hotblack Desiato cannot be reached because, “He’s spending a year dead for tax reasons.” British humor rarely makes a lot of sense, but the absurdity of this comment speaks to the flawed logic that all too many people apply to purchasing decisions.
You should never buy anything for “tax reasons.” A former colleague of mine used to say, “Don’t spend a dollar just to save fifty cents,” referring to the practice of creating expenses to reduce taxes. For example, small business owners frequently want to wipe out taxable income by purchasing large equipment at year-end, which is great if they actually need the asset but a complete waste of money if they don’t. People get so wrapped up in the appeal of saving tax dollars that they lose sight of the overall objective—wealth accumulation.
The same rule applies to home ownership—you should buy because it makes financial sense to own rather than rent, not because it will save you taxes. That being said, there are tax benefits to owning a home that you should understand. Every taxpayer gets to choose whether they will take the standard deduction ($12,600 for married filing joint in 2016) or itemize. The most common itemized deductions are home-owner related:
Unlike credit card interest, which isn’t deductible at all, and student loan interest, which is capped at $2,500, generally all of your mortgage interest is deductible. The main two requirements are that the home acquisition portion, meaning the amount borrowed to buy, build, or improve your home, is less than $1M and any other amount secured by your home, is less than $100K. So essentially, you can deduct interest on up to $1.1M in debt for your home, vacation home, or both.
Many first-time home buyers do not have a significant down payment for their house. As a result, the mortgage lender will require them to obtain mortgage insurance, which protects the lender in case of default. But the IRS essentially treats these payments as additional mortgage interest payments. However, this deduction will be limited or eliminated for married taxpayers who have adjusted gross income over $100K.
Somehow it’s easier to stomach making payments to the state if you know they will reduce your federal income tax liability. Fortunately, real property taxes are added to state income tax and property tax as another itemized deduction.
All of these expenses are reported by your lending institution on a Form 1098 that you should receive around February. These are typically the biggest deductions for people, so be sure to include this form with your tax information.
Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.