TAXING TIMES, AUGUST 2015 EDITION
By Rick Torkelson, CPA and principal of Torkelson & Associates, LLP in Petaluma, CA
If you want to earn a million dollars, first get a million dollars – the next million is a lot easier. I suppose it’s the same for buying a house, first get a house – the next one is a lot easier.
Buying a home in Sonoma County is generally easier said than done. You must sell a home with equity, get help from a friend or relative or earn more income after tax than you spend to live – and for long enough to save a down payment. I can’t tell you exactly how to buy a home, but the income tax savings might motivate you to try.
There is no deduction for the rent you pay. To save taxes, you must itemize your deductions. You can deduct the interest you pay on your mortgage and you can deduct the property taxes you pay on your home. You also must have a high enough taxable income to be in a tax bracket, but unless you have a very unusual income tax situation, you couldn’t make payments on your home unless you earned enough income to be in a tax bracket.
To give you an idea of the kind of taxes you can save buying your home, I will assume that you are in a 25% Federal income tax bracket. To be in a 25% Federal income tax bracket, you have to have a taxable income between $74,000 and $149,000. This also presumes that you are married and filing a joint return. A single taxpayer with this kind of taxable income would be in at least a 25% bracket and possibly a 28% bracket.
Let’s assume that you buy a home for $500,000 and put down $100,000. You finance $400,000 at 3.5% annually. Your house payments would be about $1,800/month on your mortgage, $600/month for your property taxes and $100/month for insurance – total payments of $2,500 per month
You don’t get to deduct all your payments – not the principal you pay nor insurance payment. In this scenario, the deductible interest for your first year would be about $13,950 and the property taxes would be $6,000. That’s a total deduction of $19,950 for the first full year.
Now let’s do the math. If you were in a 25% Federal bracket, you’d probably be in an 8% California tax bracket (or possibly in a 9.3% bracket). Your tax savings on your $19,950 in house deductions would be roughly $6,600 for the year or $550 per month. In other words, if you can afford $1,950 a month in non-deductible rent payments, you could afford $2,500 in payments to buy your own home. This would hold true too if you were paying $2,500 in rent, you could probably afford $3,200 in total house payments.
While I chose my numbers to fit a typical scenario, there are a couple of things to keep in mind. For example, if you ran out and bought a house today, your first (deductible) payment would probably be in September. For 2015, you’d only have 4 house payments and your savings for 2015 would be only a third of my example. Your biggest year of tax savings will generally be your first full year of payments.
Another issue is Private Mortgage Insurance (AKA PMI). This is insurance that a finance company will require if they are financing more than 80% of the house. PMI will typically cost from .5% to 1% of the loan on an annual basis. In my example, that would be around $250 per month and while this can be deductible, it would add a substantial cost to buying your own home.
Most mortgages are backed by the Federal government (Fannie Mai, Freddie Mac, VA or FHA) up to $417,000. After that, a Jumbo mortgage would be required and while these loans are available to qualified borrowers, they are more expensive than the 3.5% interest in my example.
As always, your situation can be unique. Run the numbers or take them to your CPA. It should be fairly easy to determine if the purchase of your home makes sense for you.
Due date for 2014 extended calendar year corporations: September 15th. Due date for 2014 extend individual tax returns: October 15th.