Did you ever notice that when you put the words "The" and "IRS" together, it spells "THEIRS?" ~Author Unknown
As Tax Day quickly approaches (April 18, 2016), I hope most of you are well on your way to filing promptly. Although I love numbers, doing hundreds of tax returns for clients is definitely not my cup of tea. But, since I also love real estate - it's time to talk taxes.
If you do not already own a primary residence, the tax benefits are arguably one of the best reasons to do so. Because there are so many different components to taxes and real estate, this is going to be a 3 part series:
- Owner-occupants in condos/single-family homes;
- Investment properties; and
- Mixing owning with investing
So... without further adieu... why everyone should own their primary residence (for those living in San Francisco with rent control at 25% of market rent, keep reading):
The IRS encourages you to take deductions for owning a primary residence. For owners of their primary residence, the tax benefits can be broken out into two separate categories:
- Annual deductions; and
- Capital Gains Exclusion
When you deduct expenses associated with owning a home, you must itemize your deductions on a Schedule A (Form 1040). For those looking at properties in the Bay Area, almost all properties will place you in a position where itemizing these ownership expenses makes sense.
Permissible deductions include real estate taxes, home mortgage interest, and mortgage insurance premiums.
Some nondeductible expenses include (despite possibly showing up on your monthly mortgage payment):
- Fire or homeowner's insurance premiums; and
- The amount applied to reduce the principal of the mortgage
For those of you that were around before the Tax Reform Act of 1986 (TRA86), you might remember when interest on all personal loans was deductible (Yes, it's true!). While the deductions are more limited now, there is a large benefit to being able to deduct real estate taxes, home mortgage interest, and mortgage insurance premiums (many of our peers around the world are not as fortunate with these deductions).
All of this comes together when thinking about your "effective" payment vs. your actual payment. For example, someone paying a mortgage of $3,000 per month will have a portion going toward interest, taxes, insurance, and principal. Of the $3,000, almost all of it will be deductible or go toward principal. As a result, the effective monthly cost of living in the house might only be $1,800 a month. In addition, as your loan ages (i.e. if you have a 30-year fixed rate mortgage and you are in year 25), your payment will have a larger amount allocated toward principal each month.
Capital Gains Exclusion
Outside of the annual deductions you receive as a homeowner, the capital gains exclusion is one of the best benefits for buying (especially in the Bay Area). Taxpayers are allowed an exclusion (up to $250,000 if single and $500,000 for a married couple filing jointly) of capital gains on the sale of their primary residence if they have lived in it for 2 out of the last 5 years before the sale date. In fact, here is a nice bedtime read for why, compared to anywhere else in the country, if you live in San Francisco you are getting one of the biggest benefits available.
While the tax benefits are great, don't forget the other expenses associated with home ownership that are not deductible (i.e. maintenance, repairs, etc.). Generally, there other "soft” factors of owning that far exceed the above costs - so keep that in mind as well!
If you ever have any questions at all, please do not hesitate to reach out. At MinnGo, we realize that real estate is not something our clients think about everyday. Lucky for you, that is what we live and breath.
Until next time.