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Your main home is the investment that provides major tax benefits through all of the stages of ownership: when you purchase it, while you own it and a generous exclusion from tax when you sell it. A. Mortgage Interest and Real Estate Tax Deduction The mortgage interest you pay on your main and your second home is tax deductible as an itemized deduction. This means that the mortgage interest you pay may reduce your taxable income when the interest that you pay meets one of the following criteria. The mortgage was taken out to build, buy or improve your home and the loan equals one million dollars or less. The mortgage doesn't exceed the amount used to buy, build or improve your home by more than $100,000. The mortgage was taken out before October 13, 1987. To get a true picture of the actual tax savings for paying mortgage interest I suggest completing two calculations. First; calculate the tax before the interest deduction. Then calculate the tax with the interest deduction. The difference between the two calculations is your actual tax savings. This calculation takes into account the standard deduction and the changes in marginal income tax rate. In 2006 the standard deduction for a single individual was $5,150 and for married filling joint couple it was $10,300. Failure to consideration the tax affect of the standard deduction may inflate the tax savings from $515 to $3,399. Marginal tax rate is the rate at which that last dollar you earned is taxed, this rate changes as your taxable income increases. Example: Jim files jointly with his spouse and their joint earnings is $220,000 they pay $40,000 in mortgage interest, pay $9,000 in property tax and $11,000 in other deductions. Their total itemized deductions are $60,000 they are in a marginal tax bracket of 33% for federal and 6% for their state so their tax savings from the $40,000 of mortgage interest could be anticipated to be $15,600 at the 39% rate. Let's do the calculation and see. This couple's deductions without the mortgage interest are $20,000. We subtract the couple's
exemptions of $6,600 and the $20,000 remaining deductions. we come up with a taxable income of $193,400.and a tax of $43,803. Then we calculate the tax with the mortgage interest added to the schedule A. The taxable income is now $154,800. Why isn't it $153,600? Answer because of the income limitation on schedule A. The tax on 154,800 is $32,748 a tax savings of $11,055 for federal income tax and $2,400 for state income tax a total of $13,455 this a savings of 33.6% not 39%, though this is still a good savings I have illustrated why we need to compare the tax from the tax table rather then just calculate the tax savings at the current tax rate. Now, let's answer the question: Why is the actual tax savings $2,145 or 5.4% less than the guestament? The answer lies in the complicated structure of the tax system. Jim and his spouse would receive some deduction if he pays mortgage interest or not. In this example they were only paying 33% federal tax on about $5,000 of taxable income and 28% federal tax on the preceding $64,750 of taxable income. The state income tax stayed at 6%. Those in the lower income levels receive less tax benefit per dollar of mortgage interest until it reaches a point that some taxpayers may not receive any direct tax benefit from the mortgage interest. Thankfully the tax benefit from mortgage interest is not the only reason to purchase a home. Regardless of tax benefit people have learned the best way to start building wealth is to own one's own home. The next tax benefit that I will cover is the tax exclusion on your main home. Those that receive a windfall because something happened in their neighborhood to greatly increase the value of their home will find that this tax benefit can more than make up for the mortgage interest tax savings they may miss out on. To help you to understand the value of an exclusion take a look at the case below: A couple purchases a home and sells it 11 months latter for a $250,000 gain. Because the asset is held less than one year this is a short term capital gain and is taxed as ordinary income. Depending on their other income the additional federal tax will range between $62,481.50 and $82,500. Many states have a state tax that would be up to $17,000. Delaying the sale by one month so that the sale qualifies for treatment as a long term capital gain the federal tax drops to $31,370. They retained up to $51,130 by just changing the closing date on the sale. Now let's see what happens when the couple meets two simple tests: The use test and the ownership test. These two tests simply ask if they owned the home and lived in it as their main home for at lease two of the last five years. If so, each spouse can exclude up to $250,000 of the gain from the sale from income tax. When they meet these two tests the federal tax is "0". In most states the state tax would also be "0".
This article was commissioned by MCCrowther Tax Service and written by Marvin Crowther as a public service to help educate the public about some of the tax benefits available to homeowners. The website for MCCrowther Tax Service is http://www.mccrowtherassoc.com and email address is listings@mccrowtherassoc.com Copywrite 2007 By Crowther Publishing
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