One way the government incentivizes the ownership of real estate is through tax deductions. There are no special tax deductions for renters, but there are for property owners. Here is a quick look into the tax benefits.
Home Owners (Occupants)
Interest paid on your loan is tax deductible.
Property tax deduction:
Property taxes paid on your property are tax deductible.
Therefore, when determining your monthly payment, consider these benefits as well as they reduce your effective monthly payment. Here is the formula:
[( Monthly Interest Payment + Monthly Property Tax Payment ) * ( Average Federal + State Tax Bracket ) ] = Monthly tax savings.
Let’s say you are planning to buy a $500,000 property with 5% down, 4% interest fixed for 30 years. The payment breakdown may as follows (the following is simply an estimate and is not based on an actual quote):
Private Mortgage Insurance: $417.00
Total payment before tax benefits = $3,306.
Let’s also say your average tax (federal + state brackets averaged out), works out to 20% of your income being paid towards taxes.
[ 1,583 (interest) + 521 (taxes) ] * 20% (average tax bracket) = $420.00 in monthly tax savings.
Therefore, your effective monthly payment after tax benefits is = $3,306.00 – 420.00 = $2,886.00.
How can I receive these savings monthly?
While you will still pay your original total payment monthly, an accountant will be able to guide you in receiving these tax savings monthly. What happens is the accountant will direct you to claim a certain amount of dependents more on your tax withholding statement (with your employer). Then, the employer will withhold less from your paycheck.
In other words, you would be taking home more pay to offset the monthly home ownership payments.
Tax credits are separate from tax deductions. Tax credits may be awarded separately and in addition to your tax deductions if you apply for them and succeed in receiving them. Ask your lender if there are any current and available tax credits as they come and go quickly.
There exist many creative ways for investors to receive tax deductions from real estate.
Expensing the cost of improvements over the expected useful life of a property. Landcannot be depreciated. As an example: You own a $200,000 income property. The land is worth $100,000. You are able to depreciation the $100,000 improvement (building), less salvage value, over the expected useful life, which is usually 27.5 years. If the property has no salvage value (after 27.5 years, the property is worthless), then a simple straight line depreciation method would be: 100,000/27.5 = $3,636 in annual tax savings (or $303 in tax savings per month).
**Note: Your primary residence cannot be depreciated.
Any expenses related to the property can generally be deducted from your income taxes. Some expenses are referred to as capital improvements, and rather than being expensed immediately (deducted from your income), would be added to the depreciable value of the property and then depreciated (increasing your monthly depreciation deduction).
Some income property owners will under take what are known as “1031 tax deferred exchanges,” in which they defer paying capital gains by selling the property and buying another income producing property of greater value and greater size.
For more in-debt information on tax possibilities, please consult a professional tax accountant.
Accountant / CPA Recommendation
Bob Carey at Carey and Hanna, CPA, is an excellent, friendly, and extremely reasonable CPA. Give him a call and let him know that Kevin Paffrath sent you:
1445 Donlon Street Suite 6
Ventura CA 93003