Q Dear Rick:
I am in my early 30s and my wife is in her late 20s. We’ve been married for about five years and during that time we have been renting. My wife, more than me, has been diligent in saving money so we’ll have enough for a down payment and to do some decorating. My wife is also good at budgeting so we have a good idea of the house we can afford. The issue is with our realtor. He is a very good friend of ours and I know without question he has our best interests at heart. He says we can afford more of a home if we wish because of the various tax breaks that we will get after we buy the home. What he said was that since we do not itemize our deductions now, interest and property taxes would generate about $15,000 in deductions and that would save me about $5,000 a year in taxes. I know that something doesn’t make sense. My question for you Rick, — is there something wrong with his numbers?
Ed

A Dear Ed:
For most people buying a home is the single largest purchase they will ever make. Therefore, it is important to go into purchasing a home with your eyes wide open. I believe you should own your home as opposed to your home owning you. That is why it is important to always make sure that not only can you afford the house payments, but also the additional cost in home ownership; such as repairs, maintenance and unexpected costs that always creep up with a home.

Specifically, with regard to your question, I believe the mistake the realtor is making is they’re not factoring in the standard deductions. He is assuming the deductions the house is generating are in addition to the standard deduction; unfortunately, that is not the case. Taxpayers have two options when it comes to deductions. They can either take the standard deduction or they can itemize; they can’t do both.

Currently, the standard deduction for a married couple is $12,600. For most people, other than interest on a mortgage and property taxes, the major deductions are state and local income taxes, and charitable contributions. For example, if a married couple had $2,000 in charitable contributions and another $3,000 in state and local taxes, their total deductions would be $5,000. Therefore, in that situation, it would be better for them to take the standard deduction. If we applied this to the case at hand and we assume you still had the $5,000 in deductions between state and local taxes and charitable contributions, the $15,000 you would have from property taxes and interest would make your total deduction $20,000. Consequently, the difference for tax purposes in owning the house is the difference between the $20,000 and the $12,600 standard deduction ($20,000 – $12,600 = $7,400). The total tax implication is $7,400 in additional deductions and in your bracket that would be approximately $2,200 in tax savings, not $6,000. Once again, the mistake the realtor made was adding the deductions onto the standard deduction, which is not the way it is done.

Buying a home is wonderful and it’s very exciting. The key is to go into it with your eyes wide open. It is important that you don’t overstate the tax benefits nor purely decide to purchase the home solely based upon the tax benefits. The tax benefits are nice; however, keep in mind tax laws change and so does your tax situation. Therefore, when I look at the economics of owning a home, I generally look at the tax breaks as only the icing on the cake.

Good luck!

Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com