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Home Ownership: What are the tax benefits?

The tax code provides a number of benefits for people who own their homes. Homeowners may deduct both mortgage interest and property tax payments as well as certain other expenses from their federal income tax. They do not have to count the rental value of their homes as taxable income, even though that value is just as much a return on investment as are stock dividends or interest on a savings account. Finally, homeowners may exclude, up to a limit, the capital gain they realize from the sale of a home. All of these benefits are worth more to taxpayers in higher-income tax brackets than to those in lower brackets.

  • Homeowners who itemize deductions may reduce their taxable income by deducting any interest paid on a home mortgage. The congressional Joint Committee on Taxation (JCT) estimates that the deduction saved more than 35 million homeowners an average of over $1,850 in income tax in fiscal 2006. The deduction is limited to interest paid on up to $1 million of debt incurred to purchase or substantially rehabilitate a home. Homeowners may also deduct interest paid on up to $100,000 of home equity debt, regardless of how they use the borrowed funds. Taxpayers who do not own their home have no comparable ability to deduct interest paid on debt incurred to purchase goods and services.
  • Homeowners who itemize deductions may also reduce their taxable income by deducting property taxes they pay on their homes. That deduction is effectively a transfer of federal funds to governments that impose a property tax (mostly local but also some state governments), allowing them to raise property tax revenue at a lower cost to their constituents. The JCT estimates that the deduction saved more than 40 million homeowners an average of nearly $600 in income tax in fiscal 2006.
  • Buying a home is an investment, part of the returns from which is the opportunity to live in the home rent-free. Unlike returns from other investments, the return on homeownership—what economists call “imputed rent”—may be excluded from taxable income. In contrast, landlords must count as income the rent they receive, and renters may not deduct the rent they pay. A homeowner is effectively both landlord and renter, but the tax code treats homeowners the same as renters while ignoring their simultaneous role as their own landlords. The Office of Management and Budget estimates that the exclusion of imputed rent reduced federal revenue by nearly $29 billion in fiscal 2006.
  • Taxpayers who sell assets must generally pay capital gains tax on any profits made on the sale. But homeowners may exclude from taxable income up to $250,000 ($500,000 for joint filers) of capital gains on the sale of their home if they satisfy certain criteria: they must have maintained the home as their principal residence in two out of the preceding five years and generally may not have claimed the capital gains exclusion for the sale of another home during the previous two years. The JCT estimates that the exclusion provision saved homeowners more than $24 billion in income tax in fiscal 2006.
  • The deductions and exclusions available to homeowners are worth more to taxpayers in higher tax brackets than to those in lower brackets. For example, deducting $2,000 for property taxes paid saves a taxpayer in the 35 percent bracket $700 but saves a taxpayer in the 15 percent bracket only $300. In combination, the mortgage interest and property tax deductions reduced taxes for homeowners with income above $200,000 by an average of about $6,500 in fiscal 2006; in contrast, homeowners with income between $50,000 and $75,000 saved an average of about $1,300 (see figure). That difference results from three factors: compared with lower-income homeowners, those with higher incomes face higher marginal tax rates, typically pay more mortgage interest and property tax, and are more likely to itemize deductions on their tax returns.
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