Recently, we’ve been asked numerous times if this is a good time to buy a home in Austin. The short answer is ‘yes’. The reasons are numerous and include: prices continuing to steadily increase in most areas of Austin; mortgage rates bouncing off of historic lows and beginning to rise; inventory beginning to diminish; home values predicted to lead to appreciation in the future; and rental prices and occupancy rates moving up. Currently, in most cases, it is more affordable to buy than to rent. And while all of these are compelling reasons, one of the biggest incentives to buy is the tax benefits to homeownership.
Buying a home is a major life investment and should be taken very seriously. Consideration of your current financial status and your future plans should play a part in when and where to buy and how much to pay. Understanding the tax benefits to buying a home is critical to your decision making process so that you understand the full value of your purchase.
In most cases, homeowners can take the following tax deductions:
- Mortgage Interest
The interest you pay on the mortgage you obtain for your primary residence is deductible from the income you report in your Federal Income Tax filing. In many cases, this is a substantial amount and, in the early years of your loan, account for most of the payment you make each month. There are limitations to the amount of interest that can be deducted as well as other important considerations for those who wish to utilize this deduction. For more information, please see IRS publication 936, which you can access by clicking here. Even better, unless changes are made by the IRS, this deduction remains in effect for the life of your loan. Generally speaking, your mortgage payment will remain relatively steady throughout the time you own your home. As you make payments, the amount of interest you pay goes down while the amount you pay down your principal goes up. In other words, early in your loan you will pay more in interest (which is deductable) while later in the loan you will pay less interest. Regardless of where you are in the life of your loan, the interest is deductable, meaning your purchase today could benefit you tax-wise for years and years to come.This is one of the key advantages to owning over renting. When you rent, you may not deduct any amount of your payments from the income you report to the IRS. Therefore, every dollar less you pay in taxes due to the mortgage interest deduction is an advantage you would gain from owning instead of renting. The difference is not just between paying rent and buying.
- Points and/or Origination Fees When Obtaining a Mortgage
When purchasing a home using a mortgage loan, certain fees will be charge for the purchase to be finalized. One is the Origination Fee, which is the amount charged to the borrower (buyer) to cover the costs of providing the loan including processing the loan application, credit checks, evaluating the loan, and other expenses related to the purchase.Buyers also have an option when applying for their mortgage loan to pay discount points in order to lower the interest rate charged to the balance of the loan. In other words, a buyer can pay extra up front to decrease their monthly payments for the life of the loan by locking in a more advantageous interest rate. In some cases, the seller will pay the discount points as an incentive to the buyer to purchase their property.According to the IRS, origination fees and loan discount points are tax deductible to the buyer, in most cases. Even better, it doesn’t matter who paid the points or fees, the buyer is allowed the deduction. So even if the seller paid the discount points, the buyer gains the tax advantage. For all the details about deducting points from your taxable income, please click here to see IRS publication 936. What moving costs do you deduct when you rent? Not much!
- Mortgage Insurance Premiums
Certain mortgage loans require buyers to pay Mortgage Insurance and is stipulated at the time of purchase. In many cases, borrowers who obtain a mortgage by paying less than 20% of the purchase price as a down payment will often be required to pay Mortgage Insurance premiums. Different loan products have different requirements, so be sure you understand the structure of your mortgage loan by having your lending professional explain the loan terms to you in detail. Basically, to help buyers purchase homes without having to save 20%, they may have the option to pay a smaller down payment along with a Mortgage Insurance premium every month. This helps borrowers purchase their homes sooner.While this deduction may or may not remain in the future, as of today the premiums paid for Mortgage Insurance are generally tax deductible. In fact, the IRS recently announced that Mortgage Insurance premiums paid in 2011 will continue to be tax deductible. Some rules and limitations apply, so be sure to check the IRS website for the details on this deduction or speak with your tax professional for advice.
These three deductions can amount to a significant sum of money that you can deduct from the income you claim in your Federal Tax filing, potentially lowering the amount of tax you are required to pay each year. More importantly, those who choose to rent are not able to enjoy these tax benefits. That’s one of the primary reasons why owning a home is actually more affordable than renting in most cases today. With rental occupancy rates going up, that means demand for rentals is increasing which will lead to higher rents. As rents increase, those who are able to buy should be more inclined to do so.
But the tax benefits to owning a home don’t stop there. Barring any changes to the tax code by the IRS, besides the Points and Origination fees from the issuing of the loan and the Mortgage Interest and Mortgage Insurance Premiums that can be deducted for the life of the loan, homeowners also have two additional tax benefits they can take advantage later in the life of the loan.
Tax benefits that can be enjoyed later in the life of the loan include:
- Interest on Home Equity Loans
Over time, as you’ve continued to make your mortgage payments, the principle of your loan will decrease. At the beginning it will drop slowly (since more of the payment goes towards interest), while later in the loan it will begin to drop more rapidly. At the same time, the value of your home will change. Generally speaking, over time, a home becomes more valuable. In other words, the amount you could sell it for in the future is usually more than the amount you bought it for, especially when you look at it over a time period of 5 years or more. This is called appreciation.As you owe less principle on your mortgage loan and the home experiences appreciation, the difference between those two amounts is known as Equity. Many people use the equity in their homes to secure a loan to pay for projects, major upkeep or upgrades, or even paying off balances owed to credit cards, auto loans, or other creditors. Homeowners who consider a home equity loan must understand that they are putting up the equity in the home to act as collateral for the new loan. That means, if/when the home is sold, the home equity loan will need to be paid off in full.Just like the main mortgage loan, interest paid on the home equity loan is also tax deductible. In other words, even while you are decreasing your reported income in your Federal Tax Filing to the IRS for your original mortgage, you can further reduce your taxable income by deducting the interest on your home equity loan. There is nothing like this available to those who rent their homes.
- Profits from the Sale of your Home. Homebuying builds equity, particularly in a down market.
If you decide to sell your home, another tax advantage comes into play. Whether you are moving up, downsizing, relocating, or selling for other reasons, the profit on the sale can be exempt from Federal Income Tax. Again, barring any changes to the IRS Tax Code, sellers may be able to avoid paying income tax on up to $500,000 worth of gains made from the sale of their home. Couples can claim up to $500,000 in profits without paying income taxes on the gains while singles can claim up to $250,000 in profits. Currently, it is an IRS requirement that sellers must have lived in the home as their primary residence for at least two of the past five years to qualify for this tax benefit.In other words, if your home goes up in value while you are living in it as your primary residence and you sell it for more than you paid, the IRS will not tax you on the gains up to $500,000 (for couples). If you made gains from nearly any other investment, you would be required to report it as income and pay Capital Gains taxes. That is one of the main reasons why purchasing a home is a better overall investment than nearly every other option. While there are other tax exempt investments available, few will have the same potential as the purchase of a home.
The tax benefits to owning a home start from the date of the purchase and continue to the date of the sale. Especially right now in Austin, Texas the advantages to owning versus renting are becoming more and more important. If you are currently renting and would like more information about preparing for your first home purchase, please email us at firstname.lastname@example.org and we’ll be happy to walk you through the process and answer any questions you may have. The first step is gaining the knowledge you need to make the right decision and we highly recommend that you speak with professionals in the industry before moving forward.
Here are some thoughts:
Benefits of Renting vs. Buying
• Easier to Relocate
• Limited cost & responsibility for repairs
• Renters insurance is cheaper than homeowners insurance.
• No Property tax payments
• No equity lost to foreclosure
• Additional Perks such as Free Cable, internet, Utilities, landscaping…….(although nothing is for free!)
• Buy Low, Sell High. There has never been a better time to buy in Austin
• No Rent Hikes
• Low rates
• Neighborhoods Promote Community & Security
• No land lord
• Christmas time every April, when you get money back.
• Numerous tax benefits.
We have posted other tax-related articles on our blog in the past. Here are some links to our previous posts:
IRS Info for Mortgage Holders, posted January 31, 2011
Mortgage Insurance Remains Tax Deductible in 2011, posted January 6, 2011
Mortgage Interest Tax Break Debate, posted November 16, 2011
Questions from First-Time Homebuyers, posted November 9, 2011