The tax benefits of owning a home have been touted for many years as the primary reason it is better to own than rent. However, recent tax law changes have all but eliminated the tax deductions previously available to homeowners.
Previous Tax Laws Benefited Buyers vs. Renters
Previously, most homeowners were able to fully deduct the mortgage interest and real estate taxes they paid on their home. By taking these two deductions homeowners were able to greatly reduce their taxable income vs. renters. Accordingly, homeowners were paying far less federal taxes than renters under the prior tax laws.
The 2018 Tax Cut and Jobs Act Negated The Tax Benefits of Homeownership
The Tax Cut and Jobs Act (TCJA) attempted to simplify the tax filing process by reducing the number of individuals that needed to itemize their deductions. In doing so, they made two significant changes that affected the tax benefits of homeownership for 2018 through 2025 as follows:
- State and Local Taxes (SALT) were limited to $10,000 for single and married filing jointly tax filers. Let’s say you paid $8,000 in wage taxes, ($5,000 state plus $3,000 local) and $5,000 in real estate taxes, for a total of $13,000. Under the new SALT limit you can only deduct $10,000, thereby losing $3,000 of local tax deductions.
- TCJA nearly doubled the standard deduction from $6,500 to $12,200 for single filers and from $13,000 to $24,400 for married filing jointly filers. Accordingly, the benefit of home ownership for now begins at $12,200 for single filers and $24,400 for married filing jointly filers.
Example #1: Single Tax Filer – Rent vs. Buy
Two single tax filers make $80,000 a year, contribute 6% to their 401k, report interest income of $100, and donate $250 to charity. One tax filer rents and the other owns a home with a $300,000 mortgage at 4% for 30 years. Therefore, the homeowner has annual mortgage interest and real estate taxes of $12,000 and $4,000, respectively.
Result: The single homeowner saves $1,771 in federal taxes vs. the single renter.
Example#2 – Married Tax Filer – Rent vs. Buy
Two joint filers make $160,000 a year, contribute 6% to their 401ks, report interest income of $100, and donate $500 to charity. One joint filer rents and the other joint filer owns a home with a $400,000 mortgage at 4% for 30 years. Therefore, the homeowner has annual mortgage interest and real estate taxes of $16,000 and $5,000, respectively.
Result: The joint filer homeowner saves $462 in federal taxes vs. the joint filer renter.
The SALT Marriage Penalty Hurts The Joint Filer
The limit for State and Local Taxes is $10,000 regardless of filing status. The single filer paying $4,000 of local payroll taxes has room for $6,000 of real estate taxes to get to the $10,000 limit. Conversely, the joint filers paying $8,000 of local payroll taxes has room for only $2,000 of real estate taxes to get to the $10,000 limit. Therefore, in the above scenario, the joint filers paid $5,000 in real estate taxes, however, $3,000 was lost due to the SALT limit.
Charitable Contributions Deduction For The Homeowners
Part of the tax savings for the homeowner tax filers is the ability to deduct charitable contributions. Since the mortgage interest and real estate tax deductions pushed them over the new higher standard deduction they were also able to deduct their contributions to charity.
Calculate The Potential Tax Benefits For Your Situation
The example I used for the joint filer homeowner assumed a $400,000 mortgage for 30 years at 4% and $5,000 of R/E Taxes and $500 of contributions. Even with these significant amounts the joint filer barely exceeded the standard deduction by $2,100 for 2019. If you are married and planning to buy a home with a smaller mortgage and lower R/E taxes than my example, you may not get any tax benefit by purchasing a home. As stated above, the single tax filer has a little more wiggle room due to the lower impact of the SALT limitation. You can run your own “what-if” tax scenarios using an online tax calculator such as this one from NerdWallet.
$750,000 Cap On Mortgage Interest Deduction
The TCJA also puts a limit on the amount of home acquisition debt that supports the amount of mortgage interest deducted. Home acquisition debt is a secured loan used to buy, build, or substantially improve your principal residence or second home. Previously, homeowners were able to deduct mortgage interest on acquisition debt of up to $1 million. Beginning on December 15, 2017, homeowners may only deduct mortgage interest on home acquisition debt of $750,000 to acquire a first or second home. The reduction does not affect existing loans taken out before December 15, 2017. Loans that were taken out before December 15, 2017 may also be refinanced up to the existing amount of the loan outstanding.
Elimination of Home Equity Loan Interest Deduction
Another area that impacted by the TCJA is the ability to deduct interest on home equity loans. Under prior law, the interest from home equity loans of up to $100,000 was deductible as an itemized deduction regardless of the reason for the use of funds. Therefore, homeowners could borrow on their home equity to purchase cars or pay off credit card debt and deduct the interest expense on their tax return. Starting in 2018, The TCJA tightened the rules for the interest deduction on home equity loans for all taxpayers. This applies to both new and existing home equity loans. Taxpayers can still deduct interest on home equity loans or second mortgages that are for home acquisition debt only. Also, the combined total of the mortgages and home equity loans is subject to the overall acquisition debt limit of $750,000.
The Purchase Of A Home May Not Provide Any Tax Benefits
For many years individuals were told that it made sense to own a home vs. renting strictly for the tax benefit alone. As you can see above, the TCJA of 2018 has basically removed all of the benefits for homeowners vs. renters from 2018 through 2025. Therefore, when deciding to purchase a home it is important to understand that there will be little or no tax benefits available to you as a result of the purchase under the Tax Cut and Jobs Act until at least 2026.
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