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How Real Estate Tax Breaks Work

How Real Estate Tax Breaks Work

Tax Benefits

Homeownership is one of the most powerful tax savings vehicles available in America today.

With the extension of the mortgage insurance tax deduction through 2016, the benefits of owning a home are piled high for at least the next couple of years.

When trying to determine if it’s better to rent or own, taking into consideration the tax savings that are inherent with home ownership is a very important part of that conversation.

You cannot simply compare your current rent payment to your proposed mortgage payment for an apples to apples comparison.  Homeownership is a long term investment with long term returns.  Tax savings is one way you realize a return on your investment (mortgage payment).

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Tax Deductions

Before we start talk about tax deductions and tax credits, I strongly recommend that you make an appointment with your CPA, accountant or tax preparer to discuss the impact that owning a home will make on the amount of taxes you pay each year.

A tax deduction typically will reduce your gross taxable income, reducing the amount of income that you pay taxes on.  Examples of common tax deductions associated with home ownership include the interest paid on your mortgage loan, and your property taxes.

Here’s an example of how housing tax deductions work:

For this example, let’s say that your gross income before taxes is $50,000 a year.  We are also assuming that you own, or will buy a home with a 3.5% down payment, and carry a $300,000 mortgage loan.  Here is how homeownership will impact your tax liability.

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  • Mortgage Interest @ 4% = $12,000 annually
  • Property taxes @ 1.12% = $3,483 annually

The total tax deduction here is approximately $15,483 – which can be deducted from your gross taxable income of $50,000.  If we are only looking at the basic homeownership tax deductions, you would pay taxes on $34,517 of taxable income.

Tax Credits

A tax credit is different from a tax deduction in the sense that it does not reduce your taxable income.  A tax credit is a direct dollar for dollar offset of taxes that are owed.

For the sake of argument, let’s say that your tax liability is $10,000 total.  If your employer collected $10,000 from your pay checks, you would not get any refund at the end of the year.  If you apply a tax credit of $2,000, then your tax liability is reduced from $10,000 to $8,000, and you are due a refund.

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The most common tax credit available to home buyers today is called a Mortgage Credit Certificate, and is available to first time homebuyers that meet the income, and purchase price limits set by the program.

A Mortgage Credit Certificate (MCC) can only be set up at the time you purchase your first home.  If you are in the market to buy a home in the future, make sure you discuss this option with your mortgage lender.  Only your lender can process a mortgage credit certificate, and it can only be done at the time of purchase.

Tax Deductible Mortgage Insurance

Mortgage insurance is a forced insurance policy that you are required to pay the premiums on to protect the lender in the event that you default on your mortgage loan.  Mortgage insurance is typically required anytime you have less than a 20% down payment when purchasing your home.

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In December 2015, Congress extended the ability to treat mortgage insurance as a tax deduction for the 2015, and 2016 tax years.  This deduction is available to anyone that has mortgage insurance, and net taxable income of $109,000 or less.

Once this tax deduction expires, or if your taxable income exceeds the qualifying limits, you always have the ability to explore “lender paid mortgage insurance” which essentially adds the mortgage insurance payment to your payment in the form of a slightly higher interest rate.

By taking a higher interest rate, you convert non-deductible mortgage insurance into tax deductible mortgage interest.

Bring Home More of Your Paycheck

The most common tax savings practice that all new homeowners should do is to adjust the withholdings taken out by your employer on every pay check you receive.  The form you used to set up your withholdings is Tax Form W-4.

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It is a best practice to review your new home purchase with your CPA, accountant or tax preparer and determine how your withholdings can be changed so that you are not over paying your income taxes at the end of the year.

The extra money you receive each paycheck is just one more of the many reasons why it just makes good financial sense to own your own home.

Again, I cannot stress enough the value of reviewing your home buying decision with your CPA, accountant prior after getting pre-approved with your lender, and before making offers on homes.

Understanding the tax benefits, of homeownership will help you to be better informed, and make more educated decisions throughout the home buying process.

About the Author

Scott Schang

A 20 year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues, and making sense of complicated real estate and mortgage topics on this website since 2007

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