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By: Catherine Hawley, CFP®, posted on 08/16/2017

Why the Tax Benefits of Owning a Home Are Overrated

Why the Tax Benefits of Owning a Home Are Overrated

I see people are sometimes tempted to justify buying a home instead of renting because of the tax breaks available to homeowners. The same logic is sometimes applied when deciding to buy a bigger, more expensive house. The tax breaks, the argument goes, lessen the impact of the extra cost.

Sometimes those decisions are justified. Buying can be a good long-term decision, and the tax breaks can certainly be helpful in the right situations.

But there are also many situations in which the tax benefits of owning a home are not everything they’re made out to be. Here are three reasons why.

1. The Standard Deduction

Every married couple who files taxes jointly in 2017 is allowed to subtract $12,700 from their taxable income. This is called the standard deduction, and it’s available to everyone no matter their situation. For single filers the 2017 standard deduction is $6,350, and for head of household it’s $9,350.

The alternative to taking the standard deduction is to itemize deductions. Mortgage interest and property taxes are itemized deductions, as are things like charitable contributions and unreimbursed medical expenses.

If the sum of your itemized deductions exceeds the standard deduction, it makes sense to itemize. The catch is that you only benefit from those itemized deductions to the extent that they exceed the standard deduction.

For example, let’s say that you are married filing jointly and that your itemized deductions, including mortgage interest and property taxes, total $20,000. At face value, that’s $20,000 you get to deduct from your income at tax time.

However, you would have been able to deduct $12,700 no matter what by virtue of the standard deduction. Which means that you are really only getting the benefit of an extra $7,300 deduction. That is, of course, still helpful, but it’s a much smaller tax break than you might have assumed.

2. It's Still a Cost

Here in California, with property values through the roof, it’s pretty likely that your mortgage interest and property taxes alone will exceed the standard deduction. Which means that you’re likely to get at least some benefit from them.

Keep in mind, a deduction is simply a discount, and a discounted cost is still a cost. If you’re in the 25% tax bracket, the ability to deduct your mortgage interest means you are receiving a 25% discount. But you are still paying 75% of the bill.

There’s a tendency to view these tax breaks as a free ride, and that’s not the case. They can certainly be helpful, but at the end of the day you are still spending money.

3. Opportunity Cost

One of the biggest tax breaks from home ownership is the ability to sell your home and receive up to $500,000 in gains tax-free. Quite frankly, this one sounds pretty remarkable. Who wouldn’t want a half million dollars completely tax-free? And while it is valuable, it’s important to evaluate it in comparison to other options.

From 1980 to 2016, the average US home increased in value at a rate of about 3.6% per year. Over the same time period, stocks returned about 10.8% per year and bonds returned about 7.9% per year.

If you assume the current 15% long-term capital gains tax rate, even a conservative mix of stocks and bonds held in a taxable account likely would have significantly outperformed the average home, even after factoring in the tax-free gains that a home offers.

It is, of course, impossible to know how stock and bond returns will compare to housing prices in the future. It may look much different going forward. Recent history shows that tax-free gains, while helpful, didn’t produce better returns than other easily accessible investment options.

Don't Let Taxes Make Your Decision

There are plenty of situations in which the tax benefits of owning a home are valuable. None of this is to say that they should be ignored.

However you shouldn’t rush into buying over renting, or buying a bigger house, simply because of the tax breaks. Instead, run the numbers and understand the benefits you’re really receiving.

You may find that they’re not as big as you thought.

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