SFMortgage.com Smart Financing The Insider’s Guide

Understanding your tax advantages is essential in determining the real monthly cost of owning a home.

  1. Figure your pre-tax monthly housing expense.
  2. Determine your tax savings.
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What are the tax benefits of home ownership?

There are three primary tax benefits from home ownership:

  • Deductibility of the mortgage interest and property taxes
  • Deductibility of certain closing costs when you purchase a home
  • Profit made from the sale of a residence is tax free up to a certain limit

How does the mortgage deduction affect my monthly housing expense?

You can, within IRS rules, deduct your home mortgage interest and your property taxes from your taxable income. Most CPAs will advise that you can deduct the mortgage interest paid on a maximum of $1.1 million dollars in combined mortgage debt on your primary residence and second home; check with your CPA or tax preparer to confirm that this applies to you. In California, if you are in a high tax bracket, the savings can be substantial.

Understanding the tax benefits of purchasing is essential in determining how much it will really cost you to live in your new home. When you are renting, figuring your monthly housing cost is easy—it’s the rent. Many people decide what they can afford to pay when purchasing their first home based on their current rent. If you are paying $2500 in rent, and putting $1000 away in savings each month, then you will logically assume that you can afford to pay $3500 a month when you buy a home. However, when you own a home the formula is a little more complicated—you have to factor in the tax savings.

For a homeowner, monthly housing expense may have four components:

  • Mortgage principal—unless you are using an interest-only loan
  • Mortgage interest, including the interest on any equity line or second mortgage
  • Property tax, which in California is paid twice a year, in December and April. However, when budgeting it is best to look at it as a monthly expense. Monthly property tax can be estimated by taking the purchase price, multiplying by 1.25%, and dividing by 12.
  • Homeowner’s insurance. For a rough estimate, $100 per month for homes under $600,000, $150 per mo. for homes between $600k and $1.2 million, and $200 per mo. for homes over $1.2 million.

When you add these numbers together, you get your pre-tax monthly housing expense. This number does not factor in the tax savings. Mortgage interest and property tax are deductible. When you own a home you pay income tax on the amount of your income after your deductions for mortgage interest and property tax, subject to other IRS rules. In most circumstances, when you own your home you pay less in state and federal income tax than you do when you are renting. Determining that tax savings on a monthly basis and subtracting it from your pre-tax monthly housing expense will let you figure what it costs you to own your home after taxes. This is therental equivalent of your monthly housing expense.

To accurately figure your tax savings, you should speak with a CPA, tax preparer, or financial advisor about issues such as the alternative minimum tax, other deductions you are taking, or how tax law changes may affect the amount of your deduction for mortgage interest and property taxes. To help you, your tax person will need the approximate annual mortgage interest and property tax you will be paying based on the price range you are looking in and on current interest rates; we can help you determine that number.

What other tax savings are available to homeowners?

When you purchase your home, most of the closing costs are not tax deductible, with one exception—loan discount points or origination fees. These are tax deductible regardless of who pays them. That means that if the seller pays your closing costs you can still deduct any points paid to the lender to buy down the interest rate on the loan.

When you sell your home you can make a profit of up to $500,000 when you sell, and pay no income or capital gains taxes if you have owned and occupied it for at least two of the past five years (assuming you are married—for a single person the deduction is $250,000). You don’t have to reinvest the proceeds.