Taxes: not what you think

taxesThe past two weeks you read about how leverage and inflation turns what is otherwise a pretty ordinary investment (your home) into a pretty good one. When you fire up your trusty search engine and scour the internet for wisdom about your home as an investment, you are likely to encounter another argument in favor of buying a home: savings on income taxes.

The argument goes something like this: when you own your home, you can deduct the interest on your mortgage on your income tax return. If you rent, you lose that particular deduction.

Sounds like it makes sense, doesn’t it? Uhhh… not quite as true as they make it sound. Uncle Sam is a pretty greedy uncle to have, and he is smart. He knows about this — hey, he was the one who made the rules to begin with. So he did what any smart and greedy person will do: he started tweaking the rules to minimize the damage he suffers from it.

Here’s how:

1. If you’re “ordinary” and you don’t make a lot of money, you have what is known as the standard deduction. As of 2015/2016, that amount is $6,300 per person. Of course, with income taxes, no two people have the identical same situation, but let’s say you are single and earn $50,000. You will pay tax on income of only (50,000- 6,300 =) $47,300, because you get to deduct that $6,300 first.

If you bought the $200,000 place we talked about earlier and borrowed $150,000 at today’s rates (let’s say 4% to be generous) the maximum interest you will have paid in an entire calendar year will be less than $6,000.

You are better off taking the standard deduction.

Boom! There is no difference between a renter or a buyer.

“Aw snap!” you say, just like Google when their website malfunctions. “Sounds like this home deduction thing is just for the rich, those one percenters.”

Think again.

2. If you’re a one percenter, it doesn’t take you long to discover that once you start earning over something around $250K a year, Uncle Sam starts phasing out that deduction.

The people who benefit on their income taxes from a mortgage deduction are:

  • People who don’t earn a lot of money but can afford a high mortgage payment (figure that one out if you can)
  • People who have other deductions, such as being kind and smart to give money away to others who are needy

There may be a few other instances. The point is to be careful when you hear a real estate agent wax lyrical about how you will save a fortune on your taxes if you just buy this place from her. Ask her how much she saved last year. Be prepared for some extended humming and hawing.

Bottom line: you can indeed come out ahead on your taxes after buying your home. But it is not automatic, and it is not nearly as big as that enthusiastic agent would want you to believe. On the other hand… it won’t hurt. (For instance, you can deduct your property taxes from your income tax should you itemize.)

3 Responses to Taxes: not what you think

  1. Dave April 1, 2016 at 5:08 am #

    50,000 – 6,3000 = 47,300 ??? This doesn’t make sense, shouldn’t it be 43,700?

    • William April 1, 2016 at 9:34 am #

      Ahh, yes. They warned me old age brings memory loss, but it seems they forgot about dyslexia. Your math is better than mine. (Not counting your extra zero, of course 😉 )

  2. Ray April 1, 2016 at 1:08 pm #

    William, you didn’t even emphasize that it is a deduction, not a credit, so to find the effect on the tax bill you need to multiply by the taxpayers marginal rate.

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