patrick.net

"Well, isn’t it that once people itemize there will be other deductions besides the mortgage interest and property tax?"

Well, yes, but not a whole lot. At least not for me when I was in essentially this exact situation.

I got some sort of tax credit for insulating / weatherproofing my house, but it was pretty small (and it may have been independent of the standard deduction). I was able to count a portion of my square footage for business purposes, and I had some charitable contributions. So there was some additional benefit, but I was *nowhere near* deducting 100% of my interest payments against my income -- *maybe* 25%. (The standard deduction is quite a bit to make up for once you decide to itemize).

And, yes, depreciation on rentals is a huge benefit to landlords. I'm not sure that it serves the public interest, though.

-S

swebb says

Of my question is whether or not this Realtor already knows this and is just being disingenuous, or if they are just repeating what they hear without understanding it. (willful misrepresentation, or ignorance..?)

I wonder whether they have any real sales pitch for somebody to buy a house other than that the govt is stupid enough to bribe people according to how much mortgage interest they are paying. It's amazing to me that we have this tax provision that seems to only benefit scumbag realtors. It sure makes their job easier which might explain why they operate on a near-retard level and are incapable of creative thoughts beyond "how can I push this transaction?"

Actually it is 11,400 not 11,600.

Not to mention that regardless of how much interest you can use as a deduction, the majority of it will be lost forever. If you paid $10,000 in mortgage interest over a year and you're in the 33% tax bracket, yes your taxes will be reduced by $3,300, but the other $6,700 you paid in interest is gone.

ptiemann says

Well, isn’t it that once people itemize there will be other deductions besides the mortgage interest and property tax?

State income tax alone makes it worthwhile.

zzyzzx says

ptiemann says

Well, isn’t it that once people itemize there will be other deductions besides the mortgage interest and property tax?

State income tax alone makes it worthwhile.

It helps. In Colorado with 4.63% flat income tax the couple buying the "$1200 per month" home given in the example would likely be earning something in the $70k/year range (?). State income tax would be just north of $3000, leaving a good deal of the standard deduction intact. So yes, they would be able to deduct some of their interest payments, but not the majority. Property taxes (are they deductible?) on such a home in Denver would be around $1000 per year.

zzyzzx says

ptiemann says

Well, isn’t it that once people itemize there will be other deductions besides the mortgage interest and property tax?

State income tax alone makes it worthwhile.

Maybe. Maybe not.

For me personally, state tax plus a potential mortgage interest would be around $12k. Then add in property tax deduction. So I'd get to write off around $16 k more than than the standard deduction. So I'd save around $4k in federal income tax if I had a mortgage.

Hardly comes close to the $1200 less per month it costs me to rent vs own

bubblesitter says

Actually it is 11,400 not 11,600.

Not that it really matters, but:

For 2011: "The standard deduction should increase from $5,700 to $5,800 for single filers and from $11,400 to $11,600 for those married filing jointly."

http://www.moneybluebook.com/2011-federal-income-tax-brackets-irs-tax-rates/

I'm in the market for a $400K home in Los Angeles though... So my mortgage interest deduction+property tax on that type of home works out to around $23K in deductions (18K in interest 5K in taxes). Take 25% off my top income bracket... And I'm getting back $5750 or $480 a month off my $2600 monthly PITI... (which includes my PMI with 10% down).

So essentially... I've calculated that I'm paying only $427 more a month to OWN a 4 bedroom/2bath home... than I currently am to rent. (I'm building $5K in equity a year also... but for the first few years I consider that a wash since it's an aesthetic fixer with a pool that we will be slowly upgrading about $5K a year for the first few years).

So essentially i'm about to enter escrow on a place that is $427 more a month for a 1957 4bed/2bath with a pool.. vs. my 2 bed/2bath $1700 a month apartment rental about 15 minutes closer commute wise.

It's a toss up for us right now... It'd be a no brainer if my wife were working... All depends on how the inspection goes. We can't afford much more than aesthetic fixes and normal maintenance in the short term. My wife's eventual income is 100% savings for us though... so we aren't buying a dual income home.

I'm interested in current school zone in the 2bd apt vs the house as schools seem to be one of the largest determining factors in home price(though not in rent....odd)

Dont assume the mortgage interest deduction will be around.
What congress gave it can take away.

"On taxes, the president's framework assumes repeal of the Bush-era tax cuts for high earners, which in December were extended through 2012. The White House framework also anticipates about $1 trillion in additional tax revenue by eliminating tax carve-outs and deductions. Those include the current mortgage interest deduction and deductions for charitable contributions."

thomas.wong1986 says

Dont assume the mortgage interest deduction will be around.
What congress gave it can take away.

“On taxes, the president’s framework assumes repeal of the Bush-era tax cuts for high earners, which in December were extended through 2012. The White House framework also anticipates about $1 trillion in additional tax revenue by eliminating tax carve-outs and deductions. Those include the current mortgage interest deduction and deductions for charitable contributions.”

Would they really risk doing this though? Wouldn't it just cause a huge increase in foreclosures... I'm sure a lot of big city earners rely on the mortgage deduction... Not saying it should be that way.. But hardly seems fair to change the rules of the game after the fact...

I could see them phasing it out though... who knows... Thomas, can you send a link to where you got that quote from?

I'm basing my home purchase on the ability to deduct my mortgage, so if their really is something on the table to remove my mortgage deduction I'd really like to know that before entering escrow.. haha...

I think most people are just hearing that it's a tax write off and do not realize they are competing it with the standard deduction.

Besides interest (even deductible) is still money paid to someone. It isn't a saving if I pay someone a $1000 and get $200 back. Thats called lose $800. And lets face it if loan is structured that for a few years its all interest, that just means few years later there will be a 0 deduction when it all turns into principal payments.

With low interest rates and high housing prices right now there isn't much of a deduction as well. My folks had a loan for 10 years now, they have not claimed it once since it never was close enough to standard deduction.

http://www.npr.org/2011/04/13/135382432/obama-plan-aims-for-4-trillion-in-deficit-cuts?ft=1&f=1014

ptiemann says

Well, isn’t it that once people itemize there will be other deductions besides the mortgage interest and property tax?
IMHO, the best tax scheme is the depreciation of rental property.
2 neighbors owning comparable houses should rent them to each other (swap addresses on paper).
Think of 2 people in West San Jose with the average 600k house.. 250k land value, 350k house value can easily be substantiated by the building cost per sqft..
350k / 27 yrs = 13k annual depreciation
All deductions:
- interest (any owner can do that) $20k a year maybe?

- tax (any owner can do that) $8k a year?
- depreciation $13k

- insurance $700

- repairs (supposedly only replacement in kind, no upgrades) $4000

- administrative expense $1000
— Total: about $46k, up from $28k

First what you are advocating is fraud. That will work until you get audited and IRS does look for things like that. And if they do find it, they go through every single previous year of taxes (as audits have no expiration). It's a very fraudulent and risky behavior.

Los Angeles Renter says

Would they really risk doing this though? Wouldn’t it just cause a huge increase in foreclosures…

Bitter medicine, need the tax dollars to reduce the debt ..14T and raising.
Might well happen. Certainly do not foresee foreclosures as a result of it. What you claim as itemized deduction 12 months from now doesnt impact your ability to pay your monthly mortgage.

In addition elim MID and other tax code (the1997 gain deduction on sale of residence. $250K/500K.)
That would reduce the volitiliy of home prices.

At this point I dont think we can take another hit in any housing bubble occuring in the next 5-15 years.
A Housing bubble in 2020.. would not be pretty!

Depends on the size of your mortgage and how much you pay in state income taxes, obviously. Its a tax break for the rich. Its worth $200 a month for me...which when considering comparable local rents vs. house prices, make buying a good deal. In Charlotte.

I have had some fun responding to real estate agents when they mention that buying a home has tax advantages. They usually aren't smart enough to shut up when I mention the standard deduction issue and will argue for a while. It was valuable intel on the person who would be advising my adversaries if I decided to make an offer. (we always, with the exception of two houses, viewed the house with the listing agent.)

dodgerfanjohn says

I’m interested in current school zone in the 2bd apt vs the house as schools seem to be one of the largest determining factors in home price(though not in rent….odd)

Great elementary school near my rental.... Carpenter Elementary in Studio City. Also solid 8/10 elementary schools in Granada Hills area too... Granada Hills charter high vs North Hollywood high long term Granada seems better.

Los Angeles Renter says

So essentially… I’ve calculated that I’m paying only $427 more a month to OWN a 4 bedroom/2bath home… than I currently am to rent. (I’m building $5K in equity a year also… but for the first few years I consider that a wash since it’s an aesthetic fixer with a pool that we will be slowly upgrading about $5K a year for the first few years).

Sorry, how do you figure you're building $5k a year in equity in what is almost certainly a depreciating asset (Los Angeles real estate still has a way to fall by all measures)? Furthermore, this probably didn't occur to you, but renting would build you $5124 a year in "equity" when you put your $427 savings into a savings account.

Very noobish question for those of you who own property (in your own names; not incorporated as a business) and rent it out: isn't the money you take in from renters taxed as income?

The MID is sold as a benefit to almost everyone, however, in reality, it's only really a "big" benefit to higher income filers. My property taxes are almost double the standard deduction; add in the interest on a 500K loan and you're talking some really significant numbers; that deduction (even after you subtract out the "lost" standard deduction) is probably worth close to 10K per year for me.

For the median buyer, it's not much (if any) value besides helping a RE agent sell you a house. I've heard realtors crowing on about "how much you'll save on taxes" to a couple buying a 150K home; there's no way that their tax savings are going to amount to more than a few trips to Starbucks.

The MID and associated "RE related" deductions are a big deal to the upper-middle and upper class earners (probably about 10-15% of the population). To everyone else, it's probably a neutral or negative (they pay more tax so that I can pay less).

"Here’s the deal: Mortgage interest (including points) and real estate taxes are tax deductible. That doesn’t sound very sexy, but it adds up. Since most of what you pay for your mortgage in the first years is interest, on a $1,200 mortgage payment you get to deduct about $1,080 a month. That reduces your taxable income by about $13,000 a year. If you’re in the 25% tax bracket, that deduction is worth $270 a month.”

I'd hate to sound obvious here but what about maintence? When you rent all you have to do is cut a check..it's ALL in the rent price. Plumbing isn't covered by mortage payments...same with electrical..shoveling snow, raking leaves, home security and the list goes on...and on..and on.

Most houses are suburban in nature which means you'll need a car. Cars run on gas and where's that been going lately? Can anyone find a decent used car under 13K these days?

This person needs to look at the forest for the trees here. The long term costs are clearly outweigh the mortage deduction. It also makes an assumption that you can get a mortage to begin with.

A person renting is able to leave as many tell you to pay first and last months rent. Mortages after you pay it all you are stuck with the house (now it takes money to sell it). In a world where things move constantly why get a house?
Richard Florida hinted on this in Who's Your City..why he never expanded on it is beyong me.lightly touching on 2-3 pages when he could easily write 20-30...

Overtaxed is correct. The idea of the MID implies as if everyone can get a home and we know that is not true. There's a book called Running on Empty that refers to this as one of the lies of the left (lies on the right are that tax cuts work in the long term)

Just wanted to pop a quick comment in, from a personal perspective. I bought a home last April, but only because with the 20% down I had, my mortgage plus HOI plus property tax payment was less than half what I was paying to rent a similar house. If buying would have been more expensive than renting, even by a few hundred dollars, I would never have gone ahead. Even if the market here was stable, which it isn't (I live in southern California). The tax deductions were good for me; I had well over double the standard in the end, after itemizing. Your mileage may vary...I certainly didn't buy for tax purposes or a mistaken belief that buying a house is necessarily better than investing elsewhere. I bought because I was ready to stop renting, for me purchase made financial sense and I found exactly what I always wanted, from neighborhood to property itself.

Michinaga says

Very noobish question for those of you who own property (in your own names; not incorporated as a business) and rent it out: isn’t the money you take in from renters taxed as income?

They should by law as it is income, but in reality not everyone reports it. It is a risk, because if audit comes there are heavy penalties and wage/pension garnishment. Even if it is owned by the business, it is still considered income and IRS looks for these things because they would love to classify you as a dealer.

I remember when I was younger and rented out someones guest house it was a nightmare with a landlord who only at the end of the year realized that I was claiming rent as a tax deduction for my registered business which meant he had to pay taxes on the income (which he did not desire to).

Los Angeles Renter says

dodgerfanjohn says

I’m interested in current school zone in the 2bd apt vs the house as schools seem to be one of the largest determining factors in home price(though not in rent….odd)

Great elementary school near my rental…. Carpenter Elementary in Studio City. Also solid 8/10 elementary schools in Granada Hills area too… Granada Hills charter high vs North Hollywood high long term Granada seems better.

I was just trying to figure out where your financials come from...theres usually a reason either schools or commute. In this case, you are looking at around a 30 minute longer commute at rush hour times. 15-20 minutes only prior to 630am.

For a similiar house in North Hollywood and similiar neighborhood as Granada Hills, you are looking mostly at Valley Village and south of Riverside. Which means likely $600-700K+ for the same home as in Granada Hills.

Essentially you are comparing apples to oranges. When I made my comparison earlier in this thread, it was oranges to oranges....like properties 5 blocks from each other.

For you to rent even a house in North Hollywood, it would be MUCH less expensive than owning in that same area. If you are willing to make the longer commute, I agree that buying in Granada Hills MIGHT make sense.

FWIW, I used to live there(Valley Glen), and helped out a friend with a property in Northridge and another in North Hills. So I'm familiar with the areas and driving times.

The bulk of the Sch A deduction, mortgage interest, really only adds up and makes sense if real estate is "appreciating". There are many other deductions on Sch A though that may help people, for instance medical Expenses for elderly folks - they get all over 7.5% AGI - that can add up fast. I think you really need a bean-counter person to help you when your finances get all tangled up later in life. That being said, I have heard all my business life that you should "never use your own money" - that's what I heard the CPA Partners and their rich clients say on the other side of my little cubicle walls. I sure wish some of that money would have stuck to me - oh well.

We had a home and paid 590,000 and payments were 4,000/month. Now we rent for 2,000 for a house in a much better high-end city and we put the difference in our 401(k). Our income is about 240,000. We paid 3,000 in taxes for 2011 becayse we maxed out our 401(k) which we couldn't when we had a house payment. We also take advantage of flexible and dependent spending account at work. I love patrick and all the information I learned from his bloggers because you all convinced us to rent and save, save, save!!!!!!! Thank you!!!!!

Realtors are financial experts? Oh please.

SusanK says

We had a home and paid 590,000 and payments were 4,000/month. Now we rent for 2,000 for a house in a much better high-end city and we put the difference in our 401(k). Our income is about 240,000. We paid 3,000 in taxes for 2011 becayse we maxed out our 401(k) which we couldn’t when we had a house payment. We also take advantage of flexible and dependent spending account at work. I love patrick and all the information I learned from his bloggers because you all convinced us to rent and save, save, save!!!!!!! Thank you!!!!!

And my employer wants me to believe posting on patrick.net is a waste of time....

Blasphemy!

Tax deduction is a joke, I had a house in Maryland a few years back, did my taxes twice on Turbo Tax, once with my mortgage and once without, and the total difference was $400.00 dollars, the mortagage was 170k. I think that paying the $400.00 in taxes is a lot cheaper than giving the bank 10k a year in interest to save it. I now have a smaller house in MS and paid cash for it. The deduction line has been drilled into everyones head for so long that people just go with it. Do the comparision yourself.

Ptiemann
I haven't practiced tax work in a long time (CPA by designation, but have long since moved on), but your tax avoidance scheme has an obvious fatal flaw. The rental income you recieve on your home is taxable, while the rent you pay to your neighbor is not. So, oops, your deductions have been offset by (probably) higher income.

And, besides, the courts have long held that any transaction entered into for the sole purpose of tax avoidance is not valid. This is determined by the facts a circumstances surrounding the situation. In this case you would lose prima facia.

So, nice try but no cigar.

Fitzclarence says

Not to mention that regardless of how much interest you can use as a deduction, the majority of it will be lost forever. If you paid $10,000 in mortgage interest over a year and you’re in the 33% tax bracket, yes your taxes will be reduced by $3,300, but the other $6,700 you paid in interest is gone.

Yes. Tax deductible does NOT mean free. It means POSSIBLY discounted.

let's approach this is a simple manner. Buying a house is still a net gain for a renter base on your original example.

[ 1080(interest) - 270(recapture from tax) ] - 900 (rent) === $90 net positive.

At the end you are still a head of the game. :)

ChrisLA says

They should by law as it is income, but in reality not everyone reports it. It is a risk, because if audit comes there are heavy penalties and wage/pension garnishment.

Is rental income taxed the same as normal income? It is considered unearned income (no?)...does this mean federal income tax but not SS/Medicare/Medicaid tax?

I don't know, but I thought there might be a difference.

swebb says

ChrisLA says
They should by law as it is income, but in reality not everyone reports it. It is a risk, because if audit comes there are heavy penalties and wage/pension garnishment.
Is rental income taxed the same as normal income? It is considered unearned income (no?)…does this mean federal income tax but not SS/Medicare/Medicaid tax?
I don’t know, but I thought there might be a difference.

It's called passive income so there is no SS, FICA, etc. It's taxed at the "ordinary tax rate" after the depreciation, and all of the other deductions. Or as I like to call it, massive passive income. To answer your other question, it's NOT earned income, earned income is W-2 wage earner or 1099.

swebb says

ChrisLA says

They should by law as it is income, but in reality not everyone reports it. It is a risk, because if audit comes there are heavy penalties and wage/pension garnishment.

Is rental income taxed the same as normal income? It is considered unearned income (no?)…does this mean federal income tax but not SS/Medicare/Medicaid tax?
I don’t know, but I thought there might be a difference.

Essentially at the end of the year all income is lumped together, and rental income is considered ordinary income. But rental income is not taxed for FICA, at least for now...
Of course because it is not taxed with FICA, there are no retirement benefits gained from it (such as SS or Medicare/Medicaid).

Rob and Chris, thanks for those replies. I'm hoping to some day rent out my condo and have that money contribute toward the mortgage I'll have on my next home.

How would the government find out that you're even receiving rent? Couldn't you arrange for them to live there for "free", but on the condition that they pay $X toward the mortgage you have on your home? Is that "income"? When a parent pays rent for their college-age child, that money certainly isn't the child's "income" tax-wise. So could you escape taxes by having your tenants pay a debt for you instead of receiving cash from them?

Michinaga says

Rob and Chris, thanks for those replies. I’m hoping to some day rent out my condo and have that money contribute toward the mortgage I’ll have on my next home.
How would the government find out that you’re even receiving rent? Couldn’t you arrange for them to live there for “free”, but on the condition that they pay $X toward the mortgage you have on your home? Is that “income”? When a parent pays rent for their college-age child, that money certainly isn’t the child’s “income” tax-wise. So could you escape taxes by having your tenants pay a debt for you instead of receiving cash from them?

Michinaga: I'm sure there are lots of people renting out rooms and houses and don't report the rent, but I pay my fair share and my CPA does everything on the up and up and takes every tax advantage I'm able to take. I use a large management company to manage my properties so I get a regular statement every month and they send out 1099's to contractors that do $600.00 or more worth of work in a 12 moth period, (gardener, etc.) I would guess that some of the scoflaws would be caught in an audit when a tenant gets pissed off at the landlord and lets the tax folks know, or if a tenant takes a "renters credit" on their particular states tax form, or that when one of the maintenance people pays his/her taxes and that raises a flag because the other end isn't accounted for.........who knows, I don't worry about what other people are doing. I enjoy life and don't worry about the IRS because I have nothing in life to worry about. Good luck with your rental in the future and I'm sure it will pay off for you in the long run.