What are the tax considerations from buying and owning a home?

There are a number of tax considerations to think through when buying a home.  Among the most important for typical homebuyers are the Mortgage Interest Tax Deduction, Property Taxes (and the implications of CA Prop 13), and Tax Treatment on the Sale of a Home.  The information below is provided for informational purposes only, and should not be considered legal or tax advice. Please consult a licensed financial or tax advisor for more comprehensive information.  


The Mortgage Interest Deduction


The Mortgage Interest Deduction (MID) allows taxpayers to claim the interest on up to $[   ] of their mortgage as a deduction against their income for income tax purposes. If you had at least $750,000 in mortgage amount and were paying 4% interest per year, this would imply $30,000 in income deductions.  The net benefit of the MID depends on your marginal tax rate, and whether you are itemizing your deductions. Assuming you are at the 32% marginal rate, and are itemizing, the net benefit would be $9,600 per year, or $800 per month.


Property Taxes (and the implications of CA Prop 13)


California’s Proposition 13, passed in 1978, limits the tax rate for residential properties in California.  Under Prop 13, when a home is bought and sold, taxes on the property are initially limited to 1% of the value of the property (plus some other local taxes and assessments), and annual tax increases are capped at no more than 2%.  Since California real estate has appreciated more than 2% over the last few decades, long-term homeowners pay significantly lower property taxes than those homeowners who bought similar homes more recently (property taxes are only reassessed when homes sell or there are major home improvements).


Tax Treatment on Sale


Financial gains from the sale of a home enjoy certain advantageous federal tax treatment.  For example, taxpayers are allowed an exclusion of up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale.  This means that a sizeable amount of profit from the appreciation of a home can be enjoyed completely tax free in the event of a sale.


In California, Proposition 60 (1986) and Proposition 90 (1988) offer relief from the increase in property taxes associated with “downsizing” to a smaller property that may nonetheless have a higher fair market value than the assessed tax-value of their current property (this occurs because of California Proposition 13, explained above).  Homeowners who are over 55 or permanently disabled can transfer the most recently assessed tax-value of their current property to a new home if they move to an equal- or lower-valued property. This allows homeowners to continue paying similar property taxes to their prior home, even if they buy a new property that would otherwise carry a much higher tax bill.  

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