TAM Blog

How much tax will I save when I buy a house?

Purchasing a home in the 1^st quarter of the year should maximize the tax savings generated for the first/partial year of home ownership.

In parts of the county where the cost of purchasing a home exceeds the cost of renting a home, residential homebuyers are frequently told that they will “save taxes” by buying a home. So what does that mean? How much taxes will the homebuyer save? When will the homebuyer ‘receive’ those savings? And, what else should the homebuyer know?

Since I am neither a CPA nor an attorney, I cannot give tax and legal advice. But, as a licensed Real Estate Agent, and a Realtor with an MBA in Finance, I will take a moment to discuss some thoughts on the topic in the hope that buyers (and sellers) will invest a little time and money to research their concerns before making one of the largest investments of their lives.

Residential homebuyers frequently hear that they will “save taxes” by buying a home. The most common way for a homebuyer to “save taxes” is by electing to itemize their deductions on their annual tax returns. The IRS provides for the deduction of mortgage interest (not principal) and taxes to be deducted in the year in which they were paid (see publication 936). Note, you must elect to itemize your deductions, you must pay the expenses in the year for which you are filing your tax return, and the property must be your primary or second home.

Here’s what many homebuyers miss, though. Itemizing your deductions and ‘writing off’ your mortgage interest and tax payments only benefit the homebuyer to the extent that these payments (along with other miscellaneous deductions) exceed the annual standard deduction. Thus, not every dollar paid to mortgage interest and taxes are necessarily going to create a tax benefit – especially in the first/partial year of home ownership.

If you want to determine the actual/anticipated annual (or monthly) tax savings generated from your home purchase, here’s a general rule of thumb to use. Estimate your monthly mortgage interest expense (only the interest portion of your payment) and multiply that figure by 12. Next, add your annual property taxes. In Marin, California, property taxes are roughly 1.25% of the purchase (or assessed) price. Now, take this sum and subtract the annual standard deduction (2007 Federal Standard Deduction is $5,350-single; $10,700-married, $7,850-Head of Household). If the result is negative – no tax savings will be experienced. If the result is positive, multiply that figure by your annual tax rate that you paid on your last tax return. This is your annual tax savings. Keep in mind, your actual tax rate this year may be different from last year’s tax rate due to rate changes or changes in your income level.

Now consider this, if you purchase a home that closes escrow toward the end of the year, you may not be able to deduct enough mortgage interest and taxes to exceed the standard deduction – and you’ll have no tax benefit realized until next year. The more expensive the home, the more likely that you’re mortgage interest and tax payments – even for a partial year – will exceed the standard deduction.

Here’s an example: Joe is about to purchase a condominium in Marin, California for $400,000. He is currently a renter, and he as filed his taxes utilizing the standard deduction in the past. The monthly mortgage interest on the new property estimated to be $2,000/month, and property taxes are $420/month. If Joe closes escrow on the home on November 1, he’ll pay 2 months mortgage interest payments ($2,000 x 2 months = $4,000) and he’ll pay 2 months of taxes ($420 x 2 = $840) this year. The total of these payments equal $4,840 – which is less than Joe’s standard deduction, so Joe would not likely experience any tax advantage this year. Other variables to discuss with your CPA are prepaid points, prepaid mortgage interest and prepaid property taxes.

So, why does this matter? Because some homebuyers are receiving advice that lead them to adjust their payroll withholdings to take advantage of these tax savings. Problem is (1) the tax savings may not exist in the first (partial) year and (2) the buyers’ standard deduction must be taken into consideration when calculating the additional tax benefit generated from mortgage interest and tax payments. Homebuyers who do wish to modify their payroll withholdings to take advantage of the tax benefits of home ownership should do so only after carefully considering all the variables of tax computations and/or consulting a CPA.

So. Here’s the good news! Purchasing a home in the 1^st quarter of the year should maximize the tax savings generated for the first/partial year of home ownership. This is the time to find your new home and start experiencing the benefits of home ownership!

Mitch Todd/Realtor 415-259-7082