Homeownership Can Be Tax Deductible (To Some Extent) — Q&A with Bruce Edwards
It’s not even 2015 yet, but if you’re like many homeowners, you’re already starting to fret about the next tax day in April. Purchasing the house was already a big enough investment, and you may be wondering which expenditures are — or aren’t — tax deductible.
There are some home-related costs that can be deductible, but not as many as you may think, says Bruce Edwards, a tax attorney and a partner of Sorensen & Edwards, P.S. in Seattle, WA. For instance, property tax is deductible, but home improvement expenditures aren’t.
Edwards offers his advice to The Home Story on what homeowners should keep in mind when preparing for April 15, 2015.
The Home Story: From your professional experience, do you find that most first-time homeowners, or potential ones as they are about to make that purchase, are not informed about tax issues? Or do they tend to overlook a lot of the small tax issues that will eventually come back to bite them?
Bruce Edwards: I think it’s the latter. I think a lot of people, particularly in the economic environment that we’re in, have sort of been raised indirectly on the notion of homeownership for most of the country. Therefore their first inclination is, “Well, as soon as I can, I’m going to buy a house.” And sort of the bottom line that I would say to my daughter — and the same advice I’m giving here — is just because you might be able to swing financing to get a house doesn’t mean that you should. So I do find that people don’t ask that question of themselves as much as they should.
The first thing I would counsel a first-time homebuyer is that they shouldn’t in most cases buy the house just for taxes. The point of that is, when you buy a house, you are putting down a substantial amount of a down payment. So you don’t want to have a situation where you buy a house and then find six months or nine months after you’ve bought it either that you have to relocate or, God forbid, you lose your job or your hours are cutback — whatever the variation is — because that will inevitably complicate your life far more than the fact that you managed to get a few tax deductions.
THS: With tax day just a few months away, what are the tax considerations you would advise first-time homeowners to keep in mind?
BE: Let’s start with the two tax advantages that you have as a homeowner: one is the mortgage interest deduction and the other is the property tax deduction. Neither of those is available when you live in an apartment or with your parents.
THS: If the home is also being used as a home office, would you be eligible for any additional deductions?
BE: Yes, in limited circumstances extra tax deductions can be claimed for a home office. The IRS rules for this are quite tough and typically are not easily met. For example, the “home office” has to be a separately identifiable space that is exclusively used for business purposes. The space cannot be used both for business purposes and personal purposes. Claiming deductions for a home office is an area that has been heavily abused in the past and historically is an “audit trigger.” (Editor’s note: IRS Publication 587 contains helpful information about the home office deduction.)
The principal extra tax deductions that can be claimed are general housing expenses (such as insurance, repairs, and utilities), prorated to the square footage of the home office, as well as items that are specifically attributable to the home office area (such as the painting of the office).
Typically, it is usually not worth the extra hassle to claim these extra tax deductions, particularly when you remember that the deductions only “save” you tax dollars at your marginal tax rate. Moreover, most people use a home office on a dual-purpose basis and so are unlikely to prevail on a tax audit.
THS: How beneficial can these tax deductions really be for the homeowner?
BE: How helpful the mortgage interest and property tax deductions are going to be is a function of the marginal tax rate that you (and your spouse, if you’re married) are in. That’s a fancy way of saying, when you figure out your taxes each year, what percentage of your income, basically, is going off to the IRS? For a lot of people that is in the 20-to-30 percent range. For 2014, if you are married and your taxable income (gross income less your deductions) is between about $75,000 and $150,000, you will be in a 25 percent marginal tax bracket.
If you have a 25 percent marginal tax rate, and if your homeownership generates $10,000 in deductions for property tax and interest, the effective tax savings is $2,500 (25 percent times $10,000), which is great. But you cannot stop the analysis there. In making the decision whether to stay in an apartment or buy a home, you have to look at the complete cost of homeownership — including not only the $10,000, but also your expenditures for non-deductible utilities, repairs, and insurance. Thus, while the $2,500 in tax savings in our example is great and reduces the net cost of homeownership, most people find that, even with the tax savings, homeownership is more expensive than staying in an apartment. My experience is that it is the quality of life items (bigger internal living space, a yard and personal green spaces, separation from noisy neighbors, ability to renovate, a private garage, etc.) that tip the scale in favor of homeownership, with the tax savings a very nice benefit — like icing on a cake.
So that is a long way of saying, “Don’t let the tax tail wag the dog.” Just because you are going to spend $10,000 in interest and property taxes in a year doesn’t mean that you’ll save $10,000 in taxes.
There are plenty of things about homeownership that are not tax deductible. Here are a handful of things for homeowners to keep in mind as they prepare their taxes:
- Principal payments.
- Escrow payments that will be used to fund homeowners insurance. “You still have to make them because that’s your contract with your lender, but you can get in trouble with the boys over at Treasury if you try and claim the tax deduction for those,” says Edwards.
- Creditor mortgage insurance and creditor life insurance. Some lenders “will require that life insurance be maintained by the homebuyer,” says Edwards. “That life insurance is typically set up so it pays off the lender. It doesn’t go to your spouse.”
- Home improvements. “The amounts that all of us spend from time to time to keep our house up to snuff — whether it’s for new carpeting for the living room, a leaky roof, or you have a broken railing — all those things may be very appropriate to spend money on, but don’t claim a tax deduction for them,” says Edwards.
This article was edited on January 8, 2015 to clarify certain points.
The purpose of the discussion above is for the reader’s general information only, and such information does not necessarily reflect the opinions of Sorensen & Edwards, P.S. or any of its attorneys or clients. Sorensen & Edwards, P.S. and its attorneys do not, by providing this information, provide legal advice or undertake to legally represent any person using such materials, and the discussion here is not intended to create the attorney-client relationship. The reader should consult his or her own attorney or other qualified adviser concerning the specifics of the reader’s own situation and how the law may apply to that situation.
Similarly, this article does not reflect the views of Fannie Mae, and Fannie Mae does not endorse the positions or opinions noted herein.