The Tax Benefits of Home Ownership – Myth or Reality?

A number of questions have come up from the post I wrote a few weeks ago about buying our new home. One of the most frequent ones goes something like this:

Great job outlining the costs of homeownership, but what about the benefits? I get a tax deduction for the interest and property taxes I pay on my home!”

Today, we put the above statement to the test. Are potential tax deductions actually valuable for home owners? Of course we cannot do this without a basic understanding of the U.S. tax system. So here is a quick high level crash course*. Let’s start with the basic income tax formula:

As you can see we start with all income. This includes money you earn from your job, dividends you earn from owning stocks, interest from your savings account, and pretty much any income you can think of. Yeah, Uncle Sam looks like a greedy bastard by just looking at this line item. But don’t worry, he is far more generous than you would think. From all income we subtract above the line deductions. These include things like IRA contributions and moving expenses. Subtracting these deductions gets you to Adjusted Gross Income (AGI).

After you arrive at AGI, you can subtract the standard deduction OR itemized deductions. This a key point because the mortgage interest and property taxes that you may be able to deduct are part of the itemized deductions. We will explore that in more detail, but first let’s finish our crash course. Another item you can subtract from your AGI are exemptions. If you are in similar situation as mine (married, not a huge income, one kid) you can take 3 exemptions for a total of $12,150 ($4,050 each for tax year 2016). No kids? You can probably take 2 exemptions, one for you one for your spouse. See? Uncle Sam is not that greedy after all.

Once you subtract your exemptions you arrive at taxable income. Think of it as a subtotal, because you may qualify for some credits such as the child tax credit, or the foreign tax credit to name a few. On the other hand, you can be on the hook for other taxes. These include penalties for early withdrawals from retirement accounts, penalties for not having health coverage, and others. After subtracting credits and adding other taxes you finally arrive at the total tax you have incurred for the year.

Now that you have a better understating of the individual income tax system, let’s dive deeper into the itemized deductions since that is where mortgage interest and property taxes may be deductible.

Itemized Deductions

Itemized deductions are reported on Schedule A of Form 1040. The following chart summarizes Schedule A.

Basically, the tax code allows a bunch of random expenses as itemized deductions that you may be allowed to take IF in total, they are greater than your standard deduction. Let’s quickly go through each, and spend a little extra time on the two we care about the most.

Medical and dental expenses are exactly what they sound like. Just a couple of caveats. First, if such expenses have been reimbursed by your insurance, you are not allowed to deduct them. Seems fair since you didn’t really end up paying for them, the insurance company did. The second and less widely known caveat is that the medical and dental expenses you can deduct are only those in excess of 10% of your AGI. In other words, if your AGI is $50,000 and you had medical expenses of $6,000, only $1,000 are potentially deductible as medical expenses. Bottom line, you are unlikely to get any tax benefits out of your medical bills unless you have a very low AGI and/or you had major medical bills during the tax year.

Taxes you paid are also fairly self-explanatory. The most common items here are property taxes and state income taxes. Interest you paid, here is where mortgage interest comes in. If you are married filing jointly, you may be able to deduct all your interest payments on a maximum of $1 million in mortgage debt secured by a first or second home. The maximum is $500,000 for married taxpayers filing separately.

Gift to charity are generally deductible. Uncle Sam encourages giving back. There are few caveats here but they are beyond the scope of this article. Next, casualty and theft losses. These can have quite a few limitations, it is sufficient to say that you need to have been pretty unlucky for casualty and theft losses to bring any meaningful tax benefits.

Certain miscellaneous itemized deductions include things such as unreimbursed employee expenses and tax preparation fees. Similar to medical expenses these miscellaneous deductions are worthless unless they exceed 2% of AGI. Lastly, other miscellaneous deductions include things such as “unrecovered investment in an annuity”, “losses for Ponzi-type investment schemes”, and other obscure items that won’t apply to most people.

Bringing It All Together

Once you add all of your itemized deductions, you then compare them to the standard deduction, which for 2016 is $12,600 if you are married and file a joint return or $6,300 if you are single. Recall from our basic income tax formula that you only get to take the standard deduction OR the total of your itemized deductions. Given this rule, a smart tax payer will chose to deduct the biggest of the two.

The True Value of Home Ownership from a Tax Perspective – My Own Numbers

As you saw from our previous discussion, most itemized deductions are either limited based on your AGI, or are for unusual events and circumstances. Thus, mortgage interest and property taxes are the most likely items to have any sort of meaningful impact on your total itemized deductions. In other words, unless your mortgage interest and property taxes add up to more than your standard deduction, they are worthless. Let me show you with an example based on my own situation. Here is a summary of my itemized deductions:

Itemized Deductions (Schedule A) Amount Comments
+ Medical and dental expenses $0 Had about $1,500 of medical expenses. Got to deduct $0 due to AGI limitation
+ Taxes you paid $1,648 Annual property taxes on my house
+ Interest you paid $3,430 Annual interest on my 15-year mortgage
+ Casualty and theft losses $0 None, thankfully
+ Certain miscellaneous deductions $0 Had a small amount but got to deduct $0 due to AGI limitation
+ Other miscellaneous deductions $0 Didn’t have any deduction on this category
= Total itemized deductions $5,078

Since I’m happily married, my wife and I file a joint return, which means we get a $12,600 standard deduction. So as you can see, homeownership brings zero tax benefits to me.

Am I upset about it?

Not one bit, I’m grateful uncle Sam gives me a $12,600 standard deduction along with some other tax breaks. I’m also glad my plan for keeping my housing costs low is working out. We can also look at this from another angle. If I were paying more than $12,600 on mortgage interest and property taxes to where I got some sort of tax benefit, I would have to ask myself the following two questions:

  1. How big is the tax benefit? – let’s assume you are paying $14,000 of property taxes and mortgage interest. In this case, itemized deductions are greater than the standard deduction for married couples. Here, by virtue of owning a home, you would get a $1,400 (14,000 – 12,600) tax deduction you would have otherwise missed. Assuming you are in a 25% tax bracket, this would result in a net benefit of $350. Not bad, right? Hmm…
  2. Is there a better way? – I like this question better because remember, it is not about minimizing taxes, it is about maximizing wealth, and ultimately it is about maximizing happiness. So sure, in the above scenario you may be reducing your tax burden by about $350 or so, but you are having to spend $14,000 to do it! So yes, I think there is a better way (at least in most places in the U.S.). I wouldn’t be excited about spending $14,000 in interest and property taxes for my personal residence. Here in Raleigh, NC I could rent an apartment that fulfills all my needs for about $1,000 per month or $12,000 per year. At that point I am not getting any tax benefits because I’m renting but I’m still doing better than the guy who is spending $14,000 in interest and property taxes (remember, he still has other costs of homeownership to cover beyond the $14,000).

As you can hopefully appreciate by now, the tax benefits of homeownership are non-existent in a lot of cases. To be fair, every personal situation is different so there might be a few instances where a person may actually reap some tax benefits out of their primary home. Here are two that I can think of:

  • For example, a single homeowner who gets a standard deduction of $6,300 is more likely to have itemized deductions in excess of the standard deduction without having to pay a very high price for it.
  • Also, people who own homes in high cost of living areas may get their itemized deductions above the standard deduction without frivolously spending on mortgage interest and property taxes. If you are in this category, I would still challenge you in two ways. First, what is keeping you in a high cost of living area? If you are not earning a high income as a result of living in this expensive place and don’t have strong family ties, perhaps you should consider moving. If you do have a good reason for living in an expensive city, my second question to you is: are you sure owning a home is the best option? Perhaps my buy vs. rent article can help you answer that.

Closing Thoughts

Based on the above discussion, I say that the tax benefits of homeownership are more myth than reality. Mainly, because of the high amounts of money you have to spend on mortgage interest and property taxes before you are able to get any tax breaks. Hopefully you can use this article as a guide to run the numbers for yourself and find the optimal situation based on your own personal facts.

If you have questions, comments, or counterarguments feel free to post them in the comments section below 🙂


*Disclaimer: for the sake of brevity, some tax rules have been oversimplified and/or omitted. Do your own research and consult with a tax professional as needed.



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