Posted on: Sunday, June 27, 2004

Tax benefits can ease the cost of new home

By Albert B. Crenshaw
Washington Post

WASHINGTON — As home prices continue to soar in many parts of the country, real estate brokers and agents are increasingly eager to point out the tax benefits of home ownership, reminding potential buyers that these breaks can make a house less expensive than it seems.

Some even draw up sheets showing how the deductions for mortgage interest and property taxes reduce the real after-tax cost of the house.

But while the tax benefits are indeed real, the tax laws have become so complicated that a generalized set of calculations, which the agents typically use, may or may not reflect what a buyer will see on his or her actual tax return. Potential buyers who are thinking of relying on tax benefits to make their new houses affordable should run their own numbers though their computer or take them to an accountant to be sure they don't bite off more house than they can pay for.

The two provisions of today's tax code most likely to rearrange the numbers are the increased standard deduction for couples and the alternative minimum tax for higher-income home buyers, said Bob Scharin, editor of Warren, Gorham & Lamont/RIA's Practical Tax Strategies, a monthly journal for tax professionals.

He noted that last year Congress gave the standard deduction for married couples a big boost as part of its effort to ease the so-called marriage penalty on two-income couples. However, it's temporary unless lawmakers extend it, making planning even harder than usual.

And the alternative minimum tax continues to creep up on middle-class taxpayers, despite minor relief enacted recently.

A third key factor is the buyer's tax bracket. The higher the bracket, the more valuable the deductions become. At the same time, a person barely into a higher bracket can see his taxable income reduced to the point where he is mostly in a lower bracket, cutting the benefit.

Here are some examples Scharin put together to illustrate:

In simplest terms, the tax savings from a deduction are equal to your tax bracket. For example, assume Anne and Ben are solidly in the 25 percent tax bracket and already itemize their deductions, such as state income tax, because they exceed the standard deduction of $9,700. If they buy a house for which they will pay $10,000 a year in mortgage interest and real estate taxes, their tax saving will be $2,500 (25 percent of $10,000).

Carol and Dennis have the same income as Anne and Ben, but live in a state with no income tax. Their only itemized deductions before the home purchase are $700 in charitable contributions. Without any homeowner deductions, they would claim a standard deduction of $9,700. With the extra $10,000 of deductions, they will have itemized deductions of $10,700. Result: Their tax saving from home ownership is only $250 (25 percent of the $1,000 by which their itemized deductions exceed the standard deduction).

Another permutation: Suppose Eva and Fred itemize their deductions. Their income is at a level where only their last $1,000 of income is taxed at the 25 percent rate. (In other words, their taxable income without a home purchase is $59,100, and the 25 percent tax bracket for joint return filers begins with taxable income over $58,100. Taxable income over $14,300 but not over $58,100 is taxed at a 15 percent rate.) When Eva and Fred purchase a home, their deductions increase by $10,000, and they fall into the

15 percent tax bracket. Thus, only $1,000 of the deductions cut their tax by 25 percent; the remaining $9,000 of deductions save tax at a 15 percent rate. Result: Their tax saving is $1,600.