For years, I've been teaching clients why the house that they want to buy isn't going to help with their federal income tax liability. It's long been "common wisdom" that there are tax benefits to buying a house, but it isn't true for most people. Where did this myth come from, and why is it so hard to debunk?
A friend shared this, Homeownership No Longer Has Tax Savings, and it got me thinking about the history of this misconception. After reading this article, and mulling it over, and chatting with some friends, I think this definitely warrants a break-down.
I could write thousands of words about this, but I'm going to try to keep it simple. In keeping it simple, I won't be discussing every possibility, but rather general trends and concepts.
The tax benefit from home ownership occurs when the amount of interest paid on your mortgage loan increases your itemized deductions to the point where they exceed the standard deduction. The more interest you pay, the higher your itemized deductions, and the lower your overall tax liability.
In the 1970s and 1980s, it became common for the interest paid on home mortgage loans to be a relatively large amount of money, often exceeding the amount of the standard income tax deduction. Homeowners would itemize deductions, including the mortgage interest, lowering their taxable income. As a result, having a big mortgage could effectively reduce your income tax bill. Two things have changed in this equation, meaning that relatively few people have a tax benefit from mortgage interest. Unfortunately, the common knowledge that "buying a house will provide tax benefits" hasn't kept up with the reality of the situation.
Lower Interest AmountsWith historically low interest rates on home loans, the amount of interest being paid has plummeted. In 1980, the average home loan rate was nearly 14%. (It exceeded 16% in 1981 and 1982!) Because interest amounts are significantly lower, there is a much lower chance that the amount of your interest and other itemized deductions will exceed the standard deduction.
Higher Standard DeductionsWhile interest rates have fallen, the standard deduction amount continues to rise every year. In 1980, the standard deduction for a married couple was $3,400. In 2015, the standard deduction for a married couple was $12,600. Since the mortgage interest deduction only benefits you ask much as the mortgage interest pushes your itemized deductions over the standard deduction, high standard deductions make home ownership less tax-advantageous.
Despite the fact that the average homeowner hasn't had a tax break for mortgage interest since 2008, the old school wisdom hasn't caught up. Next time someone tells you about the tax advantages of homeownership, ask them to explore the details a little more carefully. There's a good chance that they're not saving as much as they thought (if anything!)