Understanding the Tax Benefits of Homeownership

One of the biggest benefits of homeownership is the tax benefits.  When a buyer is considering a purchase, usually cash flow of a monthly mortgage payment and calculation of the down payment are the primary focus. Often overlooked are the tax benefits that a buyer can receive with homeownership.  The California tax code allows a homeowner a number of benefits.  These benefits are broken down into three categories:  The Purchase, Mortgage Interest/Property Taxes, and the sale of the property.  Over the course of homeownership, the “write offs” that are allowed can amount to tens of thousands of dollars.

The Purchase

When purchasing homes or condos in San Diego, most of the closing costs that are incurred in a real estate transaction are not deductible.  However, there is an important exception that a buyer should be aware of. Per tax code, the IRS allows a buyer to deduct discount points and origination fees, regardless of whether the buyer actually pays for them.  This is one of the most unusual deductions, as the buyer will get the benefit even if the seller pays certain closing costs. Origination fees and points can amount to a significant deduction, as they are usually calculated as a % of the loan (usually 1%).

Mortgage Interest

Homeowners can deduct the mortgage interest charged on a loan for their personal residence in the year that it was paid. Most loans are for a longer fixed term…say 30 years. In the beginning of a loan most of the monthly payment is interest.  As a result, the initial deductions can really add up to a sizable tax benefit.   An often overlooked deduction is the fact that homeowners may also deduct interest paid on up to $100,000 of home equity debt. This benefit allows a homeowner to participate in “debt shifting” — the process of using home equity lines to consolidate debt.  If not a homeowner and you have an unsecured credit card debt of say $10k at 20% interest, none of those interest expenses would be tax deductible.  However, as a homeowner if you are able to obtain an Equity Line of credit and consolidate debt, ALL of the interest expenses become automatically deductible.

Property Taxes

Homeowners can deduct the mortgage interest charged on a loan for their personal residence in the year that it was paid. Property Tax rates are calculated at a percentage of the home value, and differ in rate percentage from county to county.  In California where the median price of a home is $500 with a 1.25% property tax rate, the deduction would be $6200 yearly. Does this make downtown San Diego living more feasible? Check out the properties currently available in the East Village market.

The Sale

In general, taxpayers who own assets can expect to pay “capital gains tax” on any profits made from the sale. One of the most valuable tax benefits for a homeowner comes at the time of sale. If a married homeowner has owned and occupied their principal residence for at least two of the last five years, they can generate up to $500k of profit on the sale of the home and have no federal income tax at all.  If not married…the deduction is obviously $250k.  A homeowner may take this deduction every two years for the rest of their lives. This encourages homeowners to purchase a home and then “trade up” with equity that they have gained as the real estate markets improve over time.