There are two primary reasons for owning residential real estate: (a) for use as a home (consumption purposes) and (b) for investment.
It's important to use all of the tax advantages available to you as owner of real estate.
Money Saving Tax Advantages of Home Ownership
Use your home and real property as a income tax write-off. Income tax deductions for property ownership include the following:
1. Mortgage interest. (interest paid on mortgage loan). The US government allows homeowners to write off interest payment on up to $1.1 million in mortgaged debt on qualified principal residence. During first years of any mortgage, the majority of money paid each month applies directly to interest, so this can be a great benefit.
2. Points paid (discount points) for Mortgage on Purchase of a home. Any discount points paid during closing of a new home are deductible if they are considered pre-paid interest. A point is 1 percent of the loan amount. Fees may be reflected on form 1098 sent by the mortgage company. Restrictions apply to deduction of points. You must verify this with your income tax professional.
3. Home loan refinance fees. If you refinance your home loan during the past year, discount points paid in process of refinancing can be deducted over the life of the new mortgage. If a person refinanced more than once, any loan fees from prior refinance that have not been deducted can be deducted in full at time of most current refinance.
4. Property taxes. These taxes paid during year are fully deductible on the income tax return for that year. Money held in escrow toward payment of your taxes is not deductible, but actual payment from escrow account toward property taxes are. This amount should also be listed on IRS form 1098.
5. Interest on home equity loans. In addition to mortgage interest, equity loan and line-of-credit interest on loans of up to $100,000 are deductible on your income tax return.
Look at the value of home ownership as the return on investment alone.
Example: You bought your home at the median price five years ago. That home would have cost you $227,160 (February 2000 single-family median home price).
In five years, the value of your investment has skyrocketed to $471,620 (February 2005 single-family median home price), reaping a 107 percent gain in the value of your home. On average that is a 20 percent per year return, which is in an amazing and positive return on your investment in any circumstances. That's nearly 3 times the nation’s return 7 percent per year over the same time period.
That return on your investment does not even take into account that the investment also provides a place to live for you and your family.
Non-Monetary Analysis
Because this investment is also your primary residence, you have a vested interest to take the proper care, i.e. renovations, maintenance, and repairs, all of which are necessary in any real estate investment. The resulting benefits are (a) improvements made to the actual structure and property, and (b) improved quality of living for you, your neighborhood, and community overall.
Investment Analysis
From a pure investment standpoint, if you decided to sell your home in 2004, $250,000 of that profit or equity is tax free if you are single and doubles to $500,000 if you are married and file a joint tax return, as long as you have lived in the home for at least 2 years and it is your primary residence (IRS Publication 523).
Let’s take a look at the February 2000 example again.
If you purchased your home in February 2000 for the then median price of $227,160 and decided to sell five years later in February 2005 for the going median price of $471,620. The equity gain on the sale of your home would be $244,460 and thus that amount earned would be tax-free.
Along with home equity gains and overall appreciation, there are other tax advantages to owning your own home — interest & property tax deductions.
Let’s look at those who have purchased a home recently. If you buy a home today at the price of $471,620 (median California price for February 2005), and if property taxes are about 1 percent of the property value, the property tax deduction for that home would be approximately $4,716 in your first year. In the first 12 months the interest paid on that home loan would total $21,420 (Interest calculated assuming a 20% downpayment with 5.71 percent FHFB February 2005 composite mortgage rate).
If you are in the 25 percent tax bracket, the total tax savings in the first year of owning the home would be around $6,530 ($26,130 interest paid & property taxes x 25 percent marginal tax bracket).
The IRS allows you to deduct the entire amount of interest paid on your home loan as long as you complete a Schedule A on your 1040, the loan is in your name, and the mortgage must be secured by collateral (usually the home itself—IRS Publication 936).
Many homeowners are also taking advantage of the ability to consolidate credit card debt and roll it into a home equity loan. The main advantage here is to deduct the interest on the home equity loan as the first mortgage deduction rules apply. Interest on credit card debt is non-deductible and rates charged are typically higher than that of the rates charged on home equity loans.
By using these advantages, owners of homes and real estate are able to better handle debt and improve their financial situation.
Owners of real estate and homes have advantages when income tax season comes around. Get the most out of yours.
