Tax Advantages of Purchasing a Home
I remember when I purchased my first home thinking I now had the advantage and luxury of no longer dealing with a landlord and worrying about rent increases when the lease expired. Also, I was able to decorate my home any way I wanted to without being afraid to change the color or put nails in the wall. (As a side note, since my fiancé has begun slowly moving in, these decorations and colors have changed substantially.) But it turns out that owning your home has more advantages than just the sense of stability and personal touch. The purchase of a first home is going to be one of the biggest financial decisions of your lifetime and along with this comes tax advantages that renting simply cannot offer.
Upon buying your first home, most of the mortgage payment is going to be made up of interest, with only a portion going against the loan principal (unless you have an interest-only loan). As you continue to pay your mortgage each month, the payment slowly shifts from less interest to more principal. The interest paid is deductible on Schedule A of your income tax return as an itemized deduction.
The real estate taxes you pay on your residence are also deductible on Schedule A. However, if you happen to be subject to the alternative minimum tax, this deduction is eliminated as no state or property taxes can be deducted under the AMT.
For most people the act of purchasing a home, and the resulting interest and property tax deductions, increase their total itemized deductions to an amount that exceeds the standard deduction. Because of that there may be some other items that you can get a tax benefit from for the first time, such as contributions to charity.
Once you have equity in the home it is possible to obtain a loan against it. One great benefit of this type of loan is that the proceeds be used for any purpose, such as paying off high-interest credit cards, purchasing a car, or starting a small business and the interest remains deductible. The interest rates for home equity loans are often much lower than credit cards, and the interest is deductible, unlike credit card interest.
One of the biggest tax advantages of owning a home is that the gain realized on the eventual sale of the home may be tax free. As long as you have lived in the home for two of the previous five years, then the first $250,000 of gain (if you’re single) is excluded from taxation. Married couples filing jointly get to exclude $500,000. There are not too many ways in life where you can earn money without being taxed, but this is one of those unique opportunities.
It’s important to consider all factors when considering the purchase of your first home. Keep these tax advantages in mind and check with us to see the potential tax savings each year of owning your first home versus renting!
Brad Zaumseil – Is a Tax Manager of Wertz & Company, LLP, a Professional Services Firm located in Orange County, CA that specializes in working with entrepreneurs along their journey to success.