For many, owning a home is part of the American dream and one that the United States government actively encourages through a variety of subsidies that are designed to give more Americans the keys to their own home. Homeownership is thought to create stronger communities, build family wealth and foster economic development. Creating incentives to expand homeownership has been a staple of U.S. housing policy for decades.
While there are an array of tax-related benefits that accrue to homeowners, concerns about skyrocketing housing costs and a lack of affordable housing in some areas has called into question the wisdom and costs of some of these incentives. The Tax Cuts and Jobs Act took aim at several housing-related incentives, including the mortgage interest and property tax deductions, as well as the use of home equity lines of credit. Although all of these incentives remain a part of the tax code, each was materially modified during the legislative process.
Variables to Consider
As a result of these incentives, owning a home enjoys some structural advantages that renting does not. That, however, is not to suggest that owning a home is always the right decision and that one should never rent. The choice of renting or buying is one of the most important and impactful decisions that we are asked to make, yet many of the costs and benefits associated with buying a home are difficult to quantify. There are, however, a small number of variables that tend to have a big impact on whether renting or buying is right for you.
- The price of the home: Don’t focus solely on the sale price. Take into account broker fees, closing costs, and any capital improvements that you make to the home. Some of these costs will add to your home’s cost basis and help reduce your taxable gain when it comes time to sell your home. Be sure to keep track of them.
- The incremental costs of owning a home: These costs include property taxes and mortgage interest, monthly maintenance or association fees, as well as the cost of insurance, maintenance, and repairs. Large one-time or seasonal costs such as replacing a roof, maintaining the heating and cooling system, or paying a cooperative apartment or condominium association assessment should also be considered. Some of these costs may go unnoticed but add up over time.
- The price of an equivalent rental: By evaluating the cost per square foot to rent versus the same cost to buy you have a baseline for comparison. Each market is different, in some cities and towns there is little demand for rental apartments and they are relatively expensive because of their scarcity. In others, buying is so expensive that people rent, even when they’d prefer to buy. If a wide disparity exists in your area, the choice may become clear without the need for a lot of math.
- How long you will live in the home: In general, the longer you remain in your home the more favorable it will be to buy because the costs are amortized over a longer period of time.
- The value of the incentives: These include the tax saving attributable to the deductions for real estate taxes and mortgage interest, as well as specific incentives (for example, those offered to first-time home buyers). These may be challenging to calculate because they are based on your specific income tax situation and involve a number of variables. It may be helpful to chat with your tax advisor to get a better sense of how valuable these incentives are for you.
- The opportunity costs for the money spent on the home in excess of the rental equivalent: This includes the down payment and closing costs, as well as the costs for taxes, insurance, maintenance, and upkeep. Opportunity cost represents the benefit that you could have received had you used these funds for a different purpose (for example, invested them in stocks or bonds, or opened a business).
These are some of the variables that are most impactful in terms of quantifying the decision, but unique factors such as frequent job reassignments or the uncertainties of starting a family should also be considered.
“Purchasing” versus “Investing”
It’s also important to remember that you purchase a home, you don’t invest in a home. While a home may turn out to be an excellent investment, it is first and foremost a place to live. And while powerful incentives remain a part of the tax code, several important updates have been made that may affect home buyers in high cost of living and high-tax locales.
- Mortgage interest deduction: The amount of acquisition indebtedness decreased from $1,000,000 to $750,000, effective on loans established after December 14, 2017. Mortgages that were established prior to this date remain deductible, up to the former $1,000,000 limit, and may be refinanced without running afoul of the law.
- Home Equity Line of Credit (HELOC): These loans continue to be deductible under the new law, but only if used to buy, build, or substantially improve the home that secures the loan. In addition, the amount of total acquisition indebtedness (mortgage plus HELOC) is limited to $750,000. This is a notable departure from the old law, which allowed for the full deduction of HELOC proceeds on loan balances up to $100,000 ($50,000 if married filing separate returns), and was in addition to the $1,000,000 limit on mortgage indebtedness, even where the proceeds were used for purposes not related to home improvements. It is worth noting, however, that those subject to the Alternative Minimum Tax faced a different set of rules.
- Property Tax Deduction: The deduction for state and local taxes, including property taxes, is now capped at $10,000. This may be the most impactful of the changes in the new law, particularly for those residing in high-tax states.
One powerful incentive for homeowners that did not change under the new law is the Section 121 exclusion on the gain associated with the sale of your primary residence. The law allows homeowners to exclude up to $250,000 of the gain on the sale of their primary residence ($500,000 for married couples filing a joint return) so long as they have owned and used the home as their primary residence for at least two years out of the five years prior to the date of sale. Changes had been proposed that would have increased the length of time that a homeowner would need to live in their primary residence to qualify for the exclusion, but did not make it into the final law.
Also left unscathed is the ability to deduct points that are paid at closing to lower the interest rate on a mortgage. Points are considered prepaid interest and amortized over the life of the mortgage, but in some cases, the entire amount may be deducted in the year the home was purchased.
Combining an array of incentives and variables into an easy-to-use calculator is no small feat, but both The New York Times and Nerdwallet have made a valiant effort. Both are easy to navigate and allow the user to adjust the variables to accommodate their specific needs. A word of caution: these calculators may not have been updated for the new tax law, so it’s best to check the tax-related output with your tax advisor.
Even after all of this work, the decision may be clear only in terms of numbers on a page or may remain as elusive as ever. And that’s OK. As with most important decisions, there are many shades of gray and the results are clear only after the fact. Bottom line: understand the variables, incentives, and rules, crunch the numbers and do what works best for you.
John Male CFP®, RICP®
The Gassman Financial Group
G&G Planning Concepts, Inc.
9 East 40th Street, 5th Floor
New York, NY 10016
T| (212) 221-7067 Ext. 113
F| (585) 625-0830
Disclosure: This article is intended to provide general information, and is not intended to provide specific tax advice.