Understanding the tax advantages and disadvantages of home-ownership can save you money

Dated: 03/08/2018

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Understanding the tax advantages and disadvantages of home-ownership can save you thousands, it’s no secret that some of the major perks of home-ownership are the tax write-offs and advantages that follow the purchase.

In fact, according to a 2015 survey by the National Association of Realtors, 80% of home buyers see home-ownership as a good investment, and 43% think it’s better than investing in the stock market. Reaping the rewards of mortgage interest and property tax deductions is just one way to think of your home as an investment. But there are even more real estate–related tax advantages and disadvantages that can slip under a new homeowner’s radar.

Here’s a short list of real estate moves that trigger surprising tax issues, both pro and con.

1. Refinancing

When you refinance into a lower interest rate mortgage, the motivation tends to be the lower monthly payment or the ability to pay off your home loan faster with the same payment every month. But don’t forget to calculate the potential tax deduction based on your mortgage interest, which is the largest tax perk of home-ownership. Most homeowners are eligible to deduct 100% of the interest they pay on a mortgage, up to $1 million, on their primary residence. So if you reduce the interest you pay, you also reduce your mortgage interest deduction.

Here’s some perspective: Fewer than 30% of homeowners take their mortgage interest deduction every year. This may be because at lower income and home price levels, the standard deduction is higher than the itemized deductions for which many homeowners would be eligible. But if you do itemize every year and/or you have a relatively high (or growing) adjusted gross income, you might be surprised at your tax bill the year after you refinance to a lower interest rate. The best practice is to loop in your tax professional so they can help you plan for this and adjust your withholdings, if necessary. This way, you’ll avoid big surprise tax bills post-refi.

2. Becoming a landlord

Smart real estate investors know the complicated tax triggers that come with holding onto, renting, and selling rental properties. But what happens if you become an “accidental landlord?” There are tax implications for being a landlord even when you rent out a room for a few nights here or there, or decide to rent out part or all of your own home for a long period.

For example, rental income is subject to all the regular income taxes, both federal and state (if applicable). In some cities, you might also be required to obtain a business license and pay business taxes as a landlord. Additionally, some municipalities are cracking down and requiring people who rent their home or portions of it for very short time frames to pay hotel taxes, which might be a cost you can pass on to your tenants.

3. Remodeling

The conventional wisdom is that when you remodel your home,  save your receipts. And this is not a “save them until tax time” recommendation; it’s a “save them until you sell the place” mandate! The money you invest into improving your home over time gets added to your purchase price, or cost basis, when you sell, bringing down the amount the IRS considers to be profit or gain and reducing your chances of incurring capital gains tax. (Single homeowners can realize $250,000 of “gains” above the cost basis of their home tax-free; married couples, $500,000.) This is no surprise to most homeowners.

Here’s where many homeowners go wrong: Remodeling projects can trigger local and state tax credits. This is especially true for home improvements that increase your home’s energy efficiency, from low-flow toilets and showerheads to dual-paned windows and insulation, even solar systems and tankless water heaters. If you’re remodeling and improving your home’s energy efficiency at the same time, visit your state, county, and city websites to see what tax credits or other financial incentives you might qualify for. If you use a home equity credit line to finance your improvements (whether or not they are ecofriendly), chances are, you can deduct the interest from that loan (up to $100,000) on top of your home mortgage interest deduction. Again, don’t forget to mention this to your tax professional.

4. Renting

Renting usually isn’t thought about as an intentional decision; it’s something many people do until they can afford to buy a home or know where their career will take them, geographically speaking. But there are people who have sufficient income, savings, and stability to own a home, but haven’t purchased one yet, for various reasons.

Someone who truly doesn’t want to own a home shouldn’t buy one simply for tax reasons, but if you’ve been ambivalent about it or have been thinking about it and procrastinating, you should at least be aware of the tax implications of your fence-sitting. Some personal finance experts estimate that the average American renter works through the end of April just to earn enough income to pay taxes (federal, state, local, and sales). As you move up the income ranks, consult with your tax professional about whether homeownership might get you some tax relief

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Solomon Thomas

Solomon Thomas and the Minnesota Home Team are your Twin Cities leading real estate experts! Whether you are looking to purchase or sell a home, Solomon will provide you with a positive, enjoyable re....

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