Does Buying a House Really Reduce Your Taxes?

Buying a home has long been a sign of the American dream. To many, it signifies that you’ve “made it.”

One often-cited benefit of home ownership that I hear is that it can help lower your taxes. If this is true, that’s a great perk! But is it true? And if home ownership does lower your taxes, by how much? That’s what I set out to learn.

In this article, I examine just how much buying a home can reduce your tax bill. Let’s get to it.

Assumptions

To do this analysis, we’ll have to make some assumptions. And of course, not all of these assumptions will apply to you. That’s okay.

This isn’t meant to be a personalized analysis. Instead, it is meant to see how an average American (if there is such a thing) may benefit from homeownership.

In this analysis, we’ll assume a married couple, with no kids, who lives in California and has a household income of $108,609 (the median household income of homeowners in CA who have a mortgage, according to the US Census Bureau). Why California?

  • Selfishly, I was born in California so I just want to see the results in that state.
  • At 39+ million people, it’s the most populated state in the US. Texas, the number 2 most populous state, isn’t even close with 28+ million. So odds are, if you’re reading this, that’s where you live.

US Population Data

Currently, our hypothetical couples is renting an apartment which costs them $1,447/month (the median CA rent from the US Census Bureau). They also pay $17.25/month for renters insurance, which is the CA average, according to Value Penguin. So their current housing costs for renting are $1,464/month.

We’ll assume the home costs $529,000, which again according to the US Census Bureau, is the median owner-occupied home value in California.

CA Home Owner Data

According to a 2018 study by the National Association of REALTORS®, “88% of recent buyers take out a mortgage” instead of paying all cash for their homes. So we’ll assume this couple also takes out a mortgage.

The study also states that “first-time buyers who financed their home typically financed 93% of their home.” So that means their initial mortgage balance would be $491,970 (93% of $529,000).

We’ll assume the interest rate on their mortgage is 4.17%, which according to the Federal Reserve Bank of St. Louis, is the 30-year fixed rate mortgage average in the United States as of the day I am writing this article.

Mortgage Data

Since the couple put down less than 20%, they will also have Private Mortgage Insurance (PMI). According to Zillow, PMI costs about 0.5% of the loan balance per year. So on their $491,970 mortgage, that’s $2,460/year ($205/month).

We’ll assume the couple must pay annual property taxes of $5,290 ($441/month). This assumes a 1% property tax rate on their $529,000 home, which is the maximum the California Constitution, Article XIII A, Section 1 allows. Now there are exceptions to this, but that varies by county, city, even school district, so let’s not open that can of worms. We’ll keep it simple with 1%.

CA Constitution Excerpt

Lastly, we’ll also assume they pay annual homeowners insurance of $974 ($81/month), the CA average according to Value Penguin.

Phew! That was a lot of assumptions. You’ll see I tried to use medians or averages wherever possible, and use the most credible sources I could find. I don’t want anybody complaining about the assumptions made in this analysis.

Results

So where do all those assumptions leave us? It leaves our hypothetical couple with a total annual housing cost of $37,486 ($3,124/month). That’s $1,660 more per month than they were paying as renters. Said another way, that’s more than 2x the cost.

Housing Cost

If you’re familiar with income taxes, you know that there are 2 key deductions that homeowners receive. These are called Itemized Deductions and go on Schedule A of your Federal Tax Return.

  1. Mortgage interest
  2. Property taxes

In the 1st year they own their home, they will pay a total of $20,356 in mortgage interest, and $5,290 in property taxes, totaling a whopping $25,646 in tax deductions just from their new home! Add that to their California income tax of $2,482 (which is also a Federal Itemized Deduction), and you get total Itemized Deductions of $28,128. That sounds amazing. But wait…

You only benefit from those deductions that are higher than the standard deduction you would have gotten anyways. In 2019, the Federal Standard Deduction for a married couple will be $24,400. So that means our couple really only benefits from $3,728 of their deductions.

Federal Itemized vs. Standard Deduction

At their income level, our couple is in the 22% Federal marginal tax bracket. So that extra $3,728 of deductions saves them about $820 in Federal income tax for the year, or about $68/month.

But what about state taxes? The California standard deduction for a married couple is $8,802, compared to their new California itemized deductions of $25,646 (less than their Federal itemized deductions because they don’t get to deduct the state income tax they paid. Only the mortgage interest and the property taxes).

CA Standard vs. Itemized Deductions

That’s an extra $16,844 of CA deductions! That’s enough to drop them from the 8% CA bracket down to the 6% bracket, and save them an estimated $1,232 in CA taxes per year, or $103/month.

When we add the Federal and California tax savings together, our couple is saving $2,052 in taxes for the year, or $171/month. Not too bad. That can be used to offset the higher monthly cost of owning a home. This brings their total housing cost from $3,124/month down to $2,953.

Net Housing Cost

But is it $171/month in tax savings enough to justify an extra $1,489 in housing costs? The additional housing cost is almost 9x the tax savings! Isn’t that like paying somebody $10 just to get $1 in return?

Wrapping It All Up

So now we’ve seen the numbers. Does owning a home, on average, reduce your taxes? Yes! In this hypothetical scenario, by an average of $171/month. The reason that number isn’t higher because of the standard deductions, particularly at the Federal level since the Tax Cuts and Jobs Act.

But what does this all mean? You shouldn’t buy a home?

NO!

That is not the conclusion I draw from this analysis at all. There are plenty of reasons why buying a home can be a great idea. Potential appreciation. Putting down roots. Forced savings. The list goes on.

However, I don’t think you should buy a house simply because you will get a tax deduction! In reality, the tax savings is much smaller than most people believe it will be, and the additional costs of home ownership usually more than offset the tax savings (and we didn’t even talk about repairs/maintenance yet!).

So buy your home. Get your piece of the American dream. But don’t do it for tax purposes.

And please remember, this is not personalized investment or tax advice. This scenario is completely hypothetical, although it is based off what I believe to be an average American. Please run your own analysis before purchasing a home.

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