Besides providing shelter, the purchase of a home can provide a number of tax and financial benefits. In fact, the tax laws have long been favorable to home ownership and recent changes have made them even more so.
For instance, interest paid on your home mortgage (and even your secondary residence) is fully deductible. The effect of this deductibility is that the government is subsidizing the purchase of your home. Following is an example of this benefit assuming two years into a $250,000 mortgage (80% loan),
6% interest rate and taxpayer marginal tax bracket of 30% state & local*.
Average Interest Portion
Assumed Tax Rate Applied
Reduction in Taxes Due to Interest Deduction
Net Mortgage Payment
Another way of looking at the benefit of the interest deduction is to recognize that a renter would be paying yearly income taxes of $4,360 more than a homeowner while making the same monthly payments!
Historically, real estate has also experienced favorable appreciation and, currently, a significant portion of the appreciation that is realized on the sale of your primary residence is tax-free. This tax-free benefit is up to $250,000 for a single individual and $500,000 for a married couple. The home in the above example could appreciate to over $800,000 before the taxpayers would have any potential taxable gain. Even then the gain would be taxed at more favorable capital gain rates as low as 0%. How many investments are there where the government helps you finance your purchase and allows you to pocket up to $250,000/$500,000 profit tax-free?
The general rule for being able to use this $250,000/$500,000 exclusion for a property owner is that the property must be owned and used by the owner as a principal residence for periods aggregating two years or more out of a five consecutive year period.
The combination of appreciation and mortgage amortization creates equity in your home that can provide a relatively inexpensive and easily accessible source of financing. You can borrow against your home equity to finance home improvements, education expenses, automobiles, vacations, investment property or any other purpose you can imagine. Home equity loans can be set up as a term loan having fixed monthly payments or as a line of credit that can be drawn from as the homeowner sees fit. There may be limitations in some instance, but generally the interest will be fully deductible.
Each case is different so it is important to consult your tax or financial advisor to determine how you can get the most out of your home purchase.
For more detailed information, I would suggest that you contact the author of this page, Bob Hofmann, a CPA with Hofmann & Company, P.C. and a resident of MMR.
For more information on Bob Hofmann, please visit his website.
*The example used is calculated for married taxpayers filing jointly and having taxable income between $58,100 and $117,250. Couples with taxable income from $117,250 to $178,650 should use a marginal rate of 33%; from $178,650 to $319,100 should use 38%; and for taxable income over $319,100 marginal tax rates of 40% should be used in place of the 30% rate.