Mortgage Deductions and the Tax Reform: How the New Law Affects Your Tax Savings
The tax landscape for homeowners has undergone significant changes with the passage of the 'Tax Cut and Jobs Act' in January. Understanding how mortgage deductions and standard deductions interplay is crucial for anyone considering or already owning a property. This article explains the impact of the new tax law on these deductions and how it affects the tax benefits of home ownership.
Itemizing vs. Standard Deductions
Before the new tax law, taxpayers had the option to either itemize deductions or elect the standard deduction—whichever resulted in the lower tax liability. The standard deduction for a married couple filing jointly was 13,000. With the new tax law, this amount has been significantly increased to 24,000, but the itemization option has been more heavily scrutinized.
Previous Deduction Rules
To better understand the changes, it's important to review the previous rules. Previously, homeowners could routinely deduct the following:
Mortgage interest on up to 1,000,000 of mortgage balance Home equity interest on up to 100,000 of HELOC balance Property taxes State and local income taxes (SALT)Additionally, taxpayers could claim personal exemptions, with a married couple with no children receiving an exemption of 8,300. These personal exemptions reduced the taxable income in the same way as deductions did, offering a way to lower the overall tax bill.
Impact of the New Tax Law
The new tax bill has introduced several changes that significantly limit the tax benefits of home ownership:
The standard deduction for a married couple filing jointly has increased to 24,000 from 13,000. The personal exemption has been eliminated. Interest on mortgages can now only be deducted on the first 750,000 of mortgage balance. Interest on HELOCs is no longer deductible. The combined cap on SALT is now 10,000.These changes significantly narrow the scope in which homeowners can benefit from these deductions. Now, a taxpayer can only benefit from writing off mortgage interest and property tax if the itemized deductions exceed the available standard deduction.
Tax Savings for Homeowners
The net result of these changes is a sharp limitation of the tax benefits of home ownership. Without assessing the combined total of all itemized deductions, a homeowner might not see any tax savings. For example, a married couple with no children receiving a standard deduction of 24,000 would only see benefits if their total itemized deductions are higher.
To derive meaningful tax benefits, homeowners would need to have paid a substantial amount on their mortgage. For instance, a purchase price of about 425,000 with a 5% down payment would be the threshold for small benefits. Larger down payments would necessitate a higher price for any tax benefits.
Homeowners who previously benefited from HELOC interest will no longer be able to deduct this interest. This change is likely to increase their overall tax liability.
Window of Prices for Tax Benefits
Given the cap on mortgage interest and the SALT, there is a small window of prices at which buyers can derive tax benefits from home ownership.
At the lower end, a purchase price of around 425,000 would provide very small benefits. Around 937,000 would be the purchase price at which a buyer is likely to have a mortgage of around 750,000, potentially yielding more significant tax savings.
A buyer who can qualify for a purchase in this range would need to earn about 156,000 annually, possibly more, depending on their other debt service. A property purchased for 937,000 would result in a tax bill of around 12,000 a year. If the taxpayer’s state imposes a state income tax, they would not derive any benefits from deducting state income tax, and would likely pay around 7,000 in state income tax.
Property taxes would consume the cap on SALT deductions alone, meaning the only remaining benefit would be the mortgage interest deduction.
Conclusion
The new tax law has fundamentally altered the tax landscape for homeowners, significantly reducing the tax benefits of home ownership. It's essential for homeowners to understand these changes and how they can impact their financial situation. While the new law aims to simplify the tax code, it also narrows the financial advantages of home ownership.
For detailed exploration, readers can refer to comprehensive tax reform discussions available online.