Tax Deduction – how much does it really save us?

[23109VC]

Assuming an annual income of roughly $130k.
Assuming a home purchase price of $500k

100% financing. Current rates.

No other major deductions aside from state income tax, and three kids/spouse….

comparing the standard deduction, vs. what I could deduct if I had $25k in home interest to write off… how much would one really “save” by having that write off?

when comparing the price to rent a house, vs. the price to buy it – i have a hard time figuring out how much I’m really goin to ‘save” on taxes when you factor the standard deduction i’d get vs the deduction i’d get if i had a big fat house payment…

a lot of the housing areas I’m looking at have about a 2% tax rate…so while it’s not rocket science or hard math.. it seems like MOST if not all of the tax savings would get eaten up by these huge taxes…… and the cost to buy is higher than the cost to rent.

the only way to even make the cost similar is to do an interest only loan…and then you’re basidally worse off than a renter..since you’re tied to the house, ahve to fix it, and are NOT paying down any principal….

i found a house I like… a house I wouldn’t mind buyuing (for the right price…).. it’s $500k.

I can rent it for $2000/month.

why would I buy???

[meadandale]

Well, here’s the approximate math.

Assuming 100% financing on $500k at 6% your monthly payment is about $3k. Let’s say that $2700 is interest. Total payment: $36k, interest: $32400.

Let’s assume a property tax rate of 1.1% for an annual bill of $5500.

Let’s also assume about $700/yr in insurance.

Therefore, your annual carrying costs of the house are $36000 + $5500 + $700 = $42200. Your tax write off is ($2700*12 + $5500)= $37900. Assuming a 28% tax bracket, this will save you $10600/yr in taxes.

So, your net annual outlay for buying is $42200-$10600=$31600. Your taxable income is $130,000-$37900=$92000

For renting at $2k/month, your annual outlay is $24k but you will also have to pay tax on the whole $130k (since we are assuming no other write offs) this increases your tax by the amount we subtracted before ($10600) so your net annual cost would be $24000 + $10600 = $34600 (if you assign all of the loss of tax write off to housing).

So, in essence, you are paying pretty close to the same amount to rent and buy (within a few thousand dollars). However, [b]in the long term[/b], owning a property should have some tangible benefits since you will be paying off the loan with cheaper and cheaper dollars and the house will increase in value (NOTE I said ‘long term’, not short term pump and dump investment).

Of course, this simple calculation ignores the additional expenses incurred by owning a house (maintenance, water/sewer/trash, etc).

[PerryChase]

These are good calculators to play with.

http://www.mortgage-info.com/mortgage-calculators/blendedmortgageratecalculator.aspx

[sstearns2]

For the rent calculation you need to subtract the standard deduction, $5,150 if you single or $10,300 if you married.

So the rental would be $24,000 + $10,600 – $5150 (or $10,300) = $29,450 or $24,300 if your married.

And, I think it would be tough to get a 6% interest rate anymore, especially with 0 down.

If you do have a significant down payment then you have to take into account the lost return on you down payment. You can easily get 5% in a short term CD right now, so if you put $100,000 down that’s $5,000/year (say $4,000 after taxes) your giving up too.

Of course the big unknown is what real estate values are going to do. If you’re renting a house and it’s going down in value by $25,000 a year….

Scott

[meadandale]

@sstearns

“For the rent calculation you need to subtract the standard deduction, $5,150 if you single or $10,300 if you married.”

Not necessarily. On a $130k income, you would certainly have more than this in state income tax that you could write off, which means that you probably wouldn’t take the standard deduction, you’d itemize to take advantage of the higher deduction.

So, in reality, the $5k isn’t an ADDITIONAL deduction.

[jztz]

As far as tax deduction is concerned, it has to do with
a) your marginal tax rate for the mortgage portion. It may not be your highest tax braket.
b) whether AMT comes into play for you.

And I assume that you’ve already itemized before a mortage due to state tax.

The max tax saving is total deductible amount (interest + property tax) x your marginal tax rate. Your realized saving might be lower due to the above factors.

[recordsclerk]

Does anyone know at what point/income does your tax rate go up to 28%.
Thanks for any answers in advance.

[meadandale]

http://www.irs.gov/formspubs/article/0,,id=164272,00.html

[Anonymous]

You counted the tax benefits twice

meadanddale, you made several errors/simplifications that, overall, favored owning over renting (and one that favored renting).

1) The one very big error was that you counted the tax benefit twice. You subtracted it from the cost of ownership. You also added it to the cost of renting. What you should be comparing is after-tax cost of both, as shown below:

RENT vs. OWN where:

RENT = [payments to landlord + full income tax]
OWN = [payments to bank/county + full inc. tax – tax benefit]

Because the “full income tax” is on both lines, you can leave it out and just compare:

[Rental payments] vs. [Payments to bank/county – tax benefits]

2) A potential large error was to assume that the full mortgage interest and prop. taxes were additional deductions from income. This would be true only if the buyer already had deductions equal to or greater than the standard deduction.

3) Another simplification that might favor buying was to ignore the alternative minimum tax (AMT). A person subject to AMT would not be able to deduct the property tax payments from income.

4) Another simplification was to assume 100% financing, but no cost for mortgage insurance. You either pay for mortgage insurance, or you pay the opportunity cost of having your down payment amount producing no cash income.

5) One simplification you made that favored renting over owning was to ignore the state tax benefits. Due to the highly progressive tax brackets in Calif., the state tax benefit can be substantial.

You noted, properly, that making the comparison for a single year ignored some important benefits of ownership (including steady mortgage payments versus rent payments that are likely to increase). However, with a current rental cost of $24,000 per year and a true after-tax ownership cost in the neighborhood of $40,000 per year for the case above, the rental case generates very substantial cash savings from the start.

[recordsclerk]

You noted, properly, that making the comparison for a single year ignored some important benefits of ownership (including steady mortgage payments versus rent payments that are likely to increase). However, with a current rental cost of $24,000 per year and a true after-tax ownership cost in the neighborhood of $40,000 per year for the case above, the rental case generates very substantial cash savings from the start.

You make a great point about rents increaseing while mortgage payments remaining the same (if you get a traditional 30yr fixed rate loan). Although you would initially pay more for mortgage payments, taxes and insurance at some point the cost will be the same, and towards the later part of your 30 years you would be paying less then rent. We would have to speculate on rent increases to come up with the exact dollar amount, but in this basic scenario it would be something to think about. For those fortunate buyers that purchased homes 2002 and prior, their payments may already be equal to or lessor then current rent for the same home. In today’s prices it may take longer then 5 years to get to break even point, but it will still happen within the loan term.

[no_such_reality]

Not necessarily. On a $130k income, you would certainly have more

Actually, he won’t, married filing jointly, $130K taxable income yields $7800 in income tax.

So he’ll lose about $3000 in standard deduction.

He’s kind of at the sweet spot for mortgage deduction, however with 3 kids and a spouse lobbing mortgage interest, property tax deductions on may swing him into AMT.

Since his taxes are pretty simple, he should invest $19 in TaxCut/TurboTax or the equivalent and spend 15 minutes doing a mock up.

[Author]

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