Thursday, October 17, 2013

The Science Behind A Home Mortgage Interest Deduction!



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Somewhere around summer, we noticed a spike in home sales. It seemed like people who had been waiting to sell were finally convinced that home values were desirable enough. The question I get most often from people looking to either buy their first home or upgrade is, if the home mortgage interest deduction on their taxes is a factor they should consider when purchasing. 

My answer to them is to think about their cash flow and not about the deductibility of  the home mortgage interest. What does that mean? Let me explain the "Science" behind the Home Mortgage Interest Deduction. 

What Is A Deduction?
In tax parlance, a deduction is expenditure that lowers income which is taxed. These are
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offered to taxpayers, 


  • By way of the Standard Deduction which is a fixed amount based on one's filing status (2013: Single or Married filing separately: $6,100, Married filing jointly or Qualifying widow(er): $12,200, Head of household: $8,950) OR 
  • By way of Itemized Deductions, taken on Schedule A on your Form 1040. The Home Mortgage Interest Deduction is a part of your Itemized Deductions which include among other things, your property taxes, charitable contributions, out-of-pocket medical expenses above a threshold etc. 

How Does This Work 
with Your Cash Flow?
One would take all the items available on Schedule A and look at the total expenditure on that. If that was more than the Standard deduction for your filing status, it would be beneficial to you to itemize. For example, if you were filing a joint return with your spouse, your total expenses would have to be more than $12,200. 

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For simplicity's sake, let's assume that you are able to itemize and your income was around $80,000, and you were filing single, you would fall into the 25% tax bracket. If your mortgage interest was $2000, you would get a benefit of $500 which is 25% of $2000. The rest of the $1,500 was still a expense that you will not be able to recuperate on your taxes. 

Crunching your numbers then, based on the calculator at interest.com, you take a 30 year mortgage of $200,000 at a 5% interest rate, we see that first year of that mortgage, which is the year with the greatest amount of interest paid, you would pay $6,184.17 in interest. For a single person in the above example, this is just around the mark where you could itemize. But you are still only getting a benefit of 25% of this $6184.17 that you spend on mortgage interest. You would have to have to hit another $6,100 in total expenses in the other categories on top of the mortgage interest to take FULL advantage of it as a deduction. 


The Bottom Line Being: 
The mortgage interest is NOT automatically deductible. In some cases, it may be partly deductible or not deductible at all. We should NOT assume it to be a benefit of home ownership, it is cash spent out-of-pocket that has to be accounted for. Maybe a tax deduction only makes it slightly cheaper. 
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Please read my disclaimer here. Please consult a tax professional for your unique situation. For any questions regarding this or other tax matters, please contact me via Email: manasa@mntaxsolutionsllc.com.