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By Tara-Nicholle Nelson, MA, Esq., FrontDoor.com | Published: 2/24/2009
Ownership has its privileges -- tax privileges, that is.
For generations, homeownership has been a core element of the American dream. Perhaps because of this, promoting homeownership through affordability-boosting tax incentives is a key element of federal tax policy. The granddaddy of the tax advantages reserved strictly for homeowners is the mortgage interest deduction.
How does this work? Many non-homeowners have very simple tax situations, so a primer on tax basics is in order. Our federal government, and many states, charge a tax on our income, and the rate at which we are taxed is proportional to our income -- the more money you make, the higher tax rate you pay. This is what people mean when they refer to your tax bracket.
We are not taxed on every single dollar we make, though. Rather, our taxes are based on our gross income minus a number of expenses the government allows us to deduct before calculating our taxes. This is known as our adjusted gross, or taxable, income.
Now to the point -- the primary tax advantage of homeownership is the mortgage interest deduction. This deduction provides that up to 100 percent of the interest you pay on your mortgage is deductible from your gross income, along with the other deductions for which you are eligible, before your tax liability is calculated. Find out how much you can deduct.
How big a deal is this? Big. Assuming your income and other expenses are the same before and after you buy a home, the mortgage interest deduction effectively reduces the amount you pay for your home. Unlike your credit cards and student loans, every mortgage is structured on an amortization schedule which allocates your monthly payments partly to interest and partly to pay off the principal balance of your mortgage. The proportion allocated to interest versus that directed to principal changes gradually over the entire life of your mortgage. In the early years of your mortgage, the majority of your mortgage payment goes to interest, rather than to reducing principal. That means that for the first years of your mortgage, your mortgage payment is almost entirely tax deductible!
In essence, the mortgage interest deduction makes owning a home more affordable. This is why people say that renters work from January to April just to pay their taxes.
The deduction basically allows homeowners to take funds they would otherwise have to give to Uncle Sam for income taxes and redirect those funds to pay a mortgage, gaining the emotional benefits of owning a home and the financial advantage of an asset with the potential to grow in value over time.
NOTE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.
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