1 Tax Break Homeowners Think They Get But Actually Don’t

Source: James Thompson.

Tax law has historically favored real estate owners. Its importance can't be dismissed -- an entire real estate boom came about in the 1980s just from one simple change in the IRS code.

Yet, despite the supposed benefits of owning your own home, taxes are, for most people, a nonstarter. Few people actually benefit from owning their home like they believe they do.

How you've been mislead
It's common that real estate agents and bankers alike suggest homeowners can save on their taxes by owning their own home. Yet, the vast majority of homeowners derive little or no tax benefit at all.

The IRS allows homeowners to deduct mortgage interest from their taxes. It's fairly straightforward: You can deduct the interest paid on up to $1 million of housing debt from your income.

Thus, if you earned $70,000 and paid $5,000 in mortgage interest, you would only pay taxes as if you had earned $65,000. Assuming your last dollar is taxed at 25%, you would avoid $1,250 in taxes, essentially paying only $3,750 in interest.

Not as simple as you might think
The math behind the mortgage interest tax deduction checks out. Reality, however, is very different from a basic example.

One thing most homeowners miss is that you receive an automatic "standard deduction" of $6,100 for singles and $12,200 for married couples filing jointly in 2013. This is a deduction you get automatically, whether your name is "Jim" or "Jamie," or you own a home or you're homeless. It's yours just for being part of the great United States of America.

Since you receive the standard deduction anyway, owning a home saves you money only if your total deductions exceed the standard deduction. Here are two examples:

A single person who pays $5,000 in mortgage interest and who has no other deductions would not benefit from the mortgage interest tax deduction. He or she would receive a standard deduction of $6,100 regardless of their homeownership status.

Likewise, a couple who pays $8,000 in mortgage interest and who claims $3,000 in additional deductions would not benefit from mortgage interest tax deductions, either. They could take the standard deduction of $12,200 vs. $11,000 in itemized deductions.

A tax break for the wealthy
The mortgage interest tax deduction is a tax break for the wealthy, not middle America. A couple who buys a $1 million dollar home would have roughly $44,669 in deductible interest in their first year. A couple who buys a $250,000 home would have $11,167 in deductible interest.

Assuming no other deductions, the wealthier couple will avoid taxes on $32,470 of income in excess of the standard deduction. The middle class family will receive no tax break at all, as their mortgage interest does not exceed the standard deduction.

Before you buy a home on the premise of avoiding Uncle Sam, do the math. Consider what your non-mortgage deductions are, and then see if the tax deduction would truly save you money. Most homeowners save little, if anything, on their tax bill by buying a home. 

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  • Report this Comment On March 03, 2014, at 4:48 AM, dsandman999 wrote:

    Mortgage interest is only one of the deductions you are likely to take if you itemize. The author misses the point of itemizing vs standard deduction. If that is the only thing you can itemize, then middle class folks will stick to the standard deduction. But, except for some states, you will also be able to deduct your state payroll taxes. Then you have local county and school taxes. You also need to itemize to take advantage of a large number of other deductions and credits. In most states, you will easily hit your numbers before you add in the mortgage interest even when you are earning far less than the example. Folks in the $70K in NY (especially NY city) NJ, PA, Deleware, almost all of New England, All the west coast, Mid-Atlantic Viginia, Deleware, Maryland, DC, Nevada, Colorado, midwest Ohio, Indiana, Michagan, Minosota, etc will hit a break even just with the above.

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