Of all the details that come across your plate when you’re buying a home, one of the questions you might be asking is, “How does buying a house affect taxes?” The short answer? Buying a home could reduce your overall tax liability if you itemize deductions and pay a large amount of mortgage interest.
There are other conditions that need to be met, and it is possible that the amount of taxes you owe will stay the same. Of course, it’s always best to consult with a tax advisor for your individual situation.
To give you a general idea about how buying a home in 2023 affects taxes, we’ve compiled everything you need to know about how tax breaks work, what you can deduct, what you can’t deduct and whether or not it will make sense to itemize deductions.
Does Buying a House Help With Taxes?
It’s possible that buying a house can help with taxes — but only for tax filers who itemize their deductions. In 2020, the most recent year with data available, more than 87% of Americans took the standard deduction rather than itemizing. This signals that it may be unlikely you’ll have enough deductions for itemizing to make sense. Of course, if it can reduce your taxes, it’s worth looking into.
You might also be wondering, “How does buying a house in cash affect taxes?” If you don’t have a mortgage, you’re not paying interest, so you’re not able to take the home mortgage interest deduction. But you’re still able to deduct property taxes if you itemize. Remember to consider this even if your property taxes are part of your mortgage payments.
How Do Homeowner Tax Breaks Work?
Tax breaks start as programs passed into law and funded by the U.S. Congress. However, it is up to individual homeowners to find and file the correct paperwork to take advantage of these tax breaks.
Tax breaks come to homeowners as either tax credits or tax deductions.
(Learn more: Home Affordability Calculator)
The Difference Between Tax Deductions and Tax Credits
The difference between a tax deduction and a tax credit is where it lies on IRS form 1040 and how much it reduces your final tax bill or refund. This will make more sense after we explain each.
Deductions On IRS Form 1040, deductions are compiled before being subtracted from your income. This is done before tax is calculated, so having deductions can reduce the overall amount of tax you owe. But because a deduction comes before tax is calculated, the reduction in tax liability is generally less than if the amount of tax owed was directly reduced by a credit (though this depends on the amount of each).
Credits Credits are subtracted from the amount of tax you owe. If you don’t owe tax but are instead receiving a tax refund, credits can increase the amount of money coming your way from the IRS. Generally speaking, credits put more money back in your pocket. You may have heard about a first-time homebuyer tax credit. A bill was introduced in 2021 that would have provided for this benefit, but as of June 2023 it had not passed into law.
Deductions are more common; however, with the revamp of the tax code in 2017 with the Tax Cuts and Jobs Act, the standard deduction was increased substantially and fewer people find the need to itemize. Nevertheless, it’s probably a good idea to add “keep track of possible tax deductions” to your list of New Year’s financial resolutions.
What Are the Standard Deduction Amounts for 2023?
It’s important to know the standard deduction amounts so you know if taking the home mortgage loan interest deduction will make financial sense for you.
- For single filers: $13,850
- For head of household: $20,800
- For married people filing jointly: $27,700
If the amount of mortgage interest you pay is far below the threshold for choosing the standard deduction, you may not be able to find enough deductions for itemizing to make sense. The increased standard deduction in 2017 made this especially true, but there are certain scenarios where you should still itemize deductions.
Who Should Itemize Deductions
You should itemize deductions if the amount of your deductions is more than the standard deduction. If you have any of the following situations, you may have enough qualified deductions for itemizing to make sense.
- If you have large medical or dental expenses that are not paid for by an insurance company
- If you paid a large amount of interest on your mortgage
- If you donated large sums to charity
- If you can claim a disaster or theft loss
- If you cannot take the standard deduction
- If you can qualify for large amounts of the “other itemized deductions” found on the IRS forms
It’s hard to say if your individual situation will make sense for itemizing deductions. It may be worth it to consult with a tax professional.
Which Home Expenses Are Tax Deductible?
When you’re looking for home expenses that are tax-deductible, the IRS defines it very narrowly. The costs that are deductible include:
- State and local real estate property taxes up to $10,000
- Home equity loan interest if you used the funds from a home equity loan on your property
Mortgage interest deduction up to defined limits:
- For loans taken out after December 15, 2017: You can deduct home mortgage interest on the first $750,000 of debt (for married couples filing jointly) or the first $375,000 of debt for a married person filing separately.
- For loans taken out prior to December 15, 2017: You can deduct home mortgage interest on the first $1,000,000 of debt (for married couples filing jointly) or the first $500,000 for separate filers.
Which Home Expenses Are Not Tax Deductible?
Most home expenses, unfortunately, are not tax deductible. These include things to budget for after buying a home. The IRS specifically outlines these living expenses that cannot be claimed as a deduction:
- Utility expenses, like gas, water, electricity, garbage, sewer, internet, etc.
- Home repairs
- Insurance
- Homeowners association or condo fees
- Cost of domestic help
- Down payment and earnest money
- Closing costs
- Depreciation
Potential tax deductions are one thing to factor into your financial considerations as you think about whether you are ready to buy a home, but they certainly aren’t what should be driving your decision to make a purchase.
The Takeaway
It is possible for the amount of tax you owe to be lower after you become a homeowner — but only with certain conditions met. You’ll want to do the math and compare what your taxes will look like when you itemize deductions vs. when you take the standard deduction. That will be the best way to tell how buying a house will affect your taxes.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 Opens A New Window.(Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
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Terms and conditions apply. Not all products are offered in all states. See SoFi.com/eligibility for more information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Can real estate help you retire early?
While people have been retiring early since there was work to shirk, the “FIRE movement” went mainstream in the early 2010s, popularized by Mr. Money Mustache and a few other bloggers.
But does financial independence necessarily mean retiring early? How do you achieve financial freedom? And what hidden pros and cons of FIRE are you probably overlooking?
Here’s your 30,000-foot view of financial independence and early retirement, plus a formula to achieve it.
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FIRE is an acronym for financial independence/retire early, or alternately financial independence/early retirement.
But those actually represent two distinct concepts. Early retirement refers to quitting your career job, never to return to the workforce. Or at least not to a high-stress, high-income career.
Increasingly, some retirees blur the line and continue working a fun job either full- or part-time. But more on that later.
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Financial independence, sometimes called financial freedom, means being able to cover your living expenses with passive income from investments. In other words, your day job becomes optional, and you no longer need to trade time for money.
For example, say you live on $4,000 per month.
You buy a rental property that generates you $500/month in rental cash flow. You like seeing that extra $500/month come in, so you buy another property, and then another. When you have $4,000 of rental cash flow coming in each month, you can live on the rents alone. You could quit your job in a blaze of glory if you liked.
Note that the term “financial independence” has two different meanings, depending on the context. Aside from the financial freedom definition, it sometimes also means the ability to pay your own bills as an independent adult. Thus, a stoner 24-year-old who spends his days playing video games in his parents’ basement and barely working is not financially independent in either sense.
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You get the gist: with enough passive income, you can pay your bills and stop working if you want.
But what should you invest in to reach financial independence and retire early? How much of a nest egg do you need?
Honestly, these are the easy parts of financial independence and early retirement. Easy enough that I can explain them in a few paragraphs.
The hard part is maintaining low living expenses and a high savings rate, month in and month out.
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As outlined above, you can invest in rental properties to generate passive income. And in doing so, you can bend, if not break entirely, the 4% Rule (more on that momentarily).
But as much as we love rental income around here at SparkRental, it’s far from the only type of passive income. You can earn passive streams of income from stock dividends, bonds, real estate crowdfunding investments, and countless other sources.
Rather than trying to pile all your money into one asset class, and earning all your passive income in one way, aim to create many passive streams of income.
For example, I earn money from rents, but also from stock dividends, real estate crowdfunding investments, private notes I’ve lent, and from businesses I own. No one source of my income would blow your mind, but they add up.
If you’re new to investing, I recommend starting with stock investing through a robo-advisor like Acorns or SoFi Invest. It requires no skill on your part, you can automate it, and you can start building an investment portfolio with $10.
When you’re ready for the next step of diversification, add a real estate crowdfunding platform like Fundrise or Groundfloor. It’s equally easy and passive, no expertise or work required.
Only consider buying your first rental property when you’re ready to pick up a new set of skills, and to devote lots of hours to it outside of your day job.
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As outlined above, financial independence requires covering your living expenses with passive income. It doesn’t require an exact net worth.
Still, traditional financial planners tell you to save up 25 times your annual spending (not your annual income!). That’s because financial planners consider 4% a safe withdrawal rate: if you pull 4% out of your retirement portfolio in the year you retire, then adjust that upward each year for inflation, your net egg should last you at least 30 years. Financial advisors refer to this as the 4% Rule.
But if you retire at 40, you need your nest egg to last you 40-60 years, not 30. In that case, a 3.5% withdrawal rate should let your nest egg keep growing forever (see this explanation from CFP Michael Kitces for the math). Rather than multiplying your annual expenses by 25, multiply it by 28.6 to reach your target nest egg for early retirement.
Note that withdrawal rates only apply to your stocks and bonds, not your real estate investments. Your real estate generates ongoing income, with no need to sell off assets.
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Most people who reach financial independence don’t actually stop working. Oh, they may quit their high-octane career job. But there are only so many days in a row you can sip margaritas on a beach before you get bored and fat.
Rather, most people simply switch to a new career that fulfills them. It may not pay well, but that doesn’t matter when you reach financial freedom. Some people start blogs or online businesses, such as travel blogs documenting their adventures. Others work for nonprofits, changing the world for the better. Some focus on writing novels, or painting, or other artistic endeavors.
But because you won’t actually stop working, you probably won’t stop earning money. You’ll just earn less than you do today — which means you don’t need to cover all of your living expenses with passive income. You just need enough to bridge the gap between what you spend and how much your dream job pays.
For example, imagine you spend $70,000 per year while working a soul-sucking job. You dream of becoming a travel writer, but that only pays $55,000. You don’t need $70,000 in passive income to quit your 9-5 job — you just need $15,000 per year, to supplement the income from your dream job.
You may not technically be financially independent, but who cares? You still get to live the same post-FIRE lifestyle without having to meet the full definition of financial freedom.
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To reach financial independence and early retirement fast, cut your living expenses as low as you can. Not only does that boost your savings rate, allowing you to funnel more money into investments, it also lowers your target passive income and nest egg. Remember, for every dollar you spend in retirement, you need $25 invested (or $28.60 if you plan to retire young)!
For maximum savings in a single move, try house hacking to score free housing.
Automate your savings with a robo-advisor, or by setting up automatic recurring transfers.
When you’re ready to expand into rental properties, read up on down payment hacks to buy a rental property with no money down. But beware of using too much leverage in real estate investing, it can leave you with negative cash flow.
You’ll be surprised how quickly your investments take on a life of their own and start generating passive income. Avoid lifestyle creep as your income rises, and keep funneling your returns and passive income back into new investments.
Honestly that’s where the challenge of financial independence and early retirement lies: not in the math or investment strategies, but in the discipline of keeping your living expenses low and your savings rate high.
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The FIRE lifestyle of low living expenses and high savings comes with some surprising perks.
To begin with, recessions are less scary. As you earn more passive income, you rely less on your 9-5 job to cover your bills. If your job disappears to a recession, you can cover many of your bills with rental income, dividends, and other passive income sources.
That same lower dependence on your day job puts you in a better position to negotiate a higher salary or benefits. You can push hard because you’re less daunted by the idea of aggravating your boss. Your world wouldn’t end if you lost your job.
Those negotiated benefits could include working remotely, allowing you to move somewhere with lower cost of living. I live in Brazil for example, allowing me to live a luxurious lifestyle on relatively few US dollars each month.
You may not need life insurance or long-term disability insurance. Low living expenses and a high savings rate means your family could probably survive on one income, if one partner shuffled off this mortal coil.
While many young adults complain that student loans prevent them from investing, living a frugal lifestyle while paying them off makes it easy to keep that “extreme savings” going. You can just start funneling that money into passive income streams and retirement savings rather than student debt.
Read up on other hidden benefits of the FIRE lifestyle here.
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Haters gonna hate — and the FIRE movement has plenty of haters.
Some say it involves too much sacrifice, that people pursuing FIRE save for the future at the expense of the present. As someone who saves 65% of his household income and spends months out of the year vacationing abroad, I can tell you firsthand that’s a bogus criticism.
The woke crowd might retort:
“Yeah but you’re a 40-year-old white male who owns an online business, you probably earn a boatload of money.”
I can assure you I do not. It took years for SparkRental to turn a profit, and even today we reinvest most of our profits back into the business. You know, doing evil things like hiring people and creating jobs.
To this day, my family lives almost entirely on my wife’s modest teacher salary.
Some whine that only married couples can achieve financial independence and early retirement. Others claim only single people can do it, citing marital disputes over money. They can’t both be right, but they can both be wrong.
Others worry about health insurance without employer coverage. Good thing you have so many health insurance options for early retirees.
Everyone has an excuse why they can’t build passive income and retire early. Most of them just don’t want to cut spending for a more frugal lifestyle — and there’s nothing wrong with that. By all means, live the normal suburban life keeping up with the Joneses. Just don’t tell me it’s impossible for middle-class people to retire at 40, because you’re wrong. Look no further than the Thompsons, who retired at 30.
Read the full list of FIRE movement criticisms, and the counterarguments from people actually living the FIRE lifestyle.
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Love it or hate it, the FIRE movement proves that not everyone has to work the standard 40-year career. Some work for 10-20 years, invest a high percentage of their income, then reach financial independence and early retirement.
I plan to work forever — doing things I love. That includes writing, building lifestyle businesses, and perhaps working in the wine industry.
And the more passive income I earn, the less I worry about how much I earn from active income.
This article originally appeared on Sparkrental.com and was syndicated by MediaFeed.org
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Featured Image Credit: andresr/istockphoto.
