[00:00:00] Speaker A: When people talk about the positives of buying your home as compared to renting, they often mention the tax benefits associated with homeownership. In this episode, we talk about how big those tax benefits actually are and whether or not you'll even get to use them based on how you file your taxes. Let's get started.
[00:00:15] Speaker B: Let's get some money from new money new problems. It's the new Money New Problems podcast, a, uh, show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
Negotiating compensation. Purchasing your first investment property. Helping your family with money. The highs and lows of entrepreneurship. New money brings new problems that require new solutions. Join us as we work through them together.
I'm Brenton Harrison, and this is the new Money New Problems podcast.
[00:00:53] Speaker A: Hello. My name is Brenton Harrison of New Money New problems, and your host for the new Money New Problems podcast. This episode is going to be, uh, the start of a topic that we're going to cover a lot in 2024, but we haven't done as much on it to date, and that is homeownership. For various reasons, I wanted to make sure that when we tackled this topic, we did it in the right way. And not everybody even wants to own a home. So instead of just doing, like, six episodes in a row on homeownership, we're going to kind of sprinkle these in amongst other topics that we have planned on our calendar. But I wanted to make sure that in this episode, we started by talking about the tax benefits associated with homeownership as compared to what you would get when you're renting. And to prepare us for the topic, we have to do a recap of how taxes work in the first place. If you're looking up on screen, we have the tax tables for the tax year 2023. That's what most people are filing right now. We're going to put a link to this in the show notes, but if you're listening, I'll describe it as if you cannot see it. We have talked about the concept of a progressive tax code in this country, and what a progressive tax code means is that not every single dollar that you earn is taxed at the same percentage. The higher your income goes, different portions of your income are, uh, taxed at higher rates than others. So when people talk about tax rates, if they say, I pay 22% in taxes, they may be mistaken. What they may be actually saying is, my marginal tax bracket is 22%. And that means that the highest portion of their taxable income is taxed at 22%, but the lower portions are taxed at substantially lower rates. And it's also important, when you hear that description, that you note the term taxable income, because taxable income is not the same as what you earned. For example, if you made $100,000 in salary, you could have a taxable income that is significantly lower than that $100,000. And the taxable income is what's actually applied to these tax brackets. So if you have an idea of how to lower that taxable income, and owning a home is one way in which you can do so, there can be a significant impact in what you pay and, uh, on how much income you pay taxes as compared to what you truly earned. You all know I love a good example on the whiteboard. So if you're looking on screen, we have an example up for you. We will again put this in the show notes, but on the screen, you have, uh, two people, left hand side, right hand side, and they both earned $100,000 in salary. And before they pay taxes on this income, they are going to access something called above the line deductions. Above the line deductions are available to anyone, no matter how you file your taxes. They are things like the amount that you contribute to your pretax retirement plans, uh, otherwise known as 401 ks, iras, 403 b's, 457 plans. The money that you put into an HSA or an FSA or a dependent care FSA. If you're an entrepreneur, half of your employment taxes go to lower your total, uh, income as an above the line deduction as well. There's all these different mechanisms that you can use, regardless of how you file, that are called above the line deductions, and they help lower that total income down to a number called adjusted gross income on your screen on both the left hand and right hand side. These people earned $100,000 each, and they each had $10,000 of above the line deductions, which brings down their taxable income to $90,000. And at this point, we have found a term called adjusted gross income. We don't have to get into too much of it today, but, you know, from past episodes, adjusted gross income is a big deal in terms of determining many of the other things for which you're eligible, in terms of deductions and credits as a taxpayer. But we've used those above the line deductions no matter how we filed. And now we have the opportunity to lower our taxable income even further. And we do that by deciding how we want to file our taxes between one of two options. The first option is that we can take what's called the standard deduction. And the second option is instead of taking the standard deduction, we can total up all of our expenses and we can choose to itemize them on our tax return. So let's start with standard deduction. What is it? Well, let's cover it. The standard deduction is an amount of money that you can deduct from your adjusted gross income to find your taxable income, which, again, is the number that will actually be applied to the federal tax brackets in 2023. If you are a single individual, the standard deduction is $13,850. If you file your taxes married, filing jointly, it is double that, $27,700. If you're married but file separately, your deduction is the same as that of a single person, and there's actually an increase in the standard deduction for those who are 65 or older or those who are blind. If you are both, you actually get to double up on that addition to your standard deduction. So, going back to our example, we have our single taxpayers, who at this point, both have an adjusted gross income of $90,000. We're going to now assume that the person on the left takes the standard deduction and lowers that adjusted gross income by $13,850. They have now reached a taxable income of $76,150, which is the amount that will be applied against the tax brackets. But on the right hand side, we're going to assume that our other taxpayer is interested in totaling up their own expenses and itemizing them on their tax return. And this is the first point in the tax planning process where the potential benefits of owning a home first start to show themselves. After the break, we'll show you how and whether or not those benefits are enough to sway this potential homeowner.
[00:06:42] Speaker C: This is the new Money New Problems podcast, uh, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen. We'll be right back.
[00:07:00] Speaker B: Are you wondering what new money problems you might be overlooking in your financial life? If so, we've got great news.
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[00:07:50] Speaker A: Before the break, we had a taxpayer who chose to, instead of taking the standard deduction, itemize their own deductions on their tax return. And any of the deductions that they use to lower that adjusted gross income are called below the line deductions. They can only be claimed if the person chooses to itemize. They cannot itemize as well as take the standard deduction. If you're looking on screen, there's a form from the IRS called a schedule a, and this is what you use to list out your itemized deductions on your return.
[00:08:21] Speaker D: You will see things here like your.
[00:08:22] Speaker A: Medical and dental expenses. And medical and dental expenses are something that is tax deductible to the extent that they exceed 7.5% of your adjusted gross income. We talked about how important that term is. So in our example, where our taxpayers have a $90,000 adjusted gross income, any of their medical expenses that go above 7.5% of that number can be used as an itemized deduction. You'll also see state and local taxes, and that's talking about things like income taxes that you might pay if you're in a state that charges an income tax or a city that charges a city tax. You will also see state and local real estate taxes and state and local personal property taxes. So this is where you start to see the actual specific line items that are relevant to your home. Because if you own a home, you have to pay property taxes. In some states, they are significantly higher than others. If you live in California, your property taxes may be higher than what we pay in Tennessee, but this is the place on your tax return where you start to claim them. And you also see home mortgage interest points. And the home mortgage interest is a huge deduction for many people who have homes that are of a certain amount.
If you have a big mortgage in the early years, you're making those payments, and it seems like your mortgage balance isn't going anywhere. Well, that's because the overwhelming majority of your payments, when you first sign up for a mortgage, are going to interest and not principal. The positive, in terms of a tax benefit at least, is that you get to claim those interest payments as a deduction on your schedule a. We won't go through all of these, but another area that you can itemize on a schedule a are your charitable or religious contributions. So when you see all these things that you can claim when you itemize. You're probably starting to put together the picture of people who are some combination of being high income earners because they're paying more in state and local taxes, being property owners because they are paying real estate property taxes, and they're paying mortgage interest, they're charitable. These people might give a lot to charity because they have discretionary income, or maybe they are of a religion that ties or gives offering at certain percentages. These are people who have discretionary income, often own property, are charitable, live in states that have high taxes themselves, and that combination of some or all of these factors can often lead these people to choose to itemize their deductions, because when they compare it to what they have with the standard deduction, it's far greater. Going back to our example of the taxpayer with a $90,000 adjusted gross income, you can imagine that if this person owned a mortgage where they were paying interest on that mortgage, and maybe they gave, uh, 10% of their income to their local church as a result of their religious beliefs, maybe they're also in a state that has state income taxes. You can start to see that there are scenarios where if they total up all of those items, it might exceed the $13,850 that they have available to them through the standard deduction. And if it does exceed it, of course you would itemize because you want to utilize whatever tools you can to have the lowest taxable income possible. But what if it doesn't exceed the standard deduction? What if you live in a state like Tennessee, where we don't have state income tax and our property taxes are relatively low compared to the rest of the country? What if you give some money to charities, but it's not 10% of your income? If you're in relatively good health and you didn't have medical expenses, at least to the point that they exceeded 7.5% of your adjusted gross income, and you can't claim any of the expenses that you did have throughout the year? Well, in that case, now we're looking.
[00:12:01] Speaker D: At these things that are available to.
[00:12:02] Speaker A: Us, and even if we're a homeowner and we have home mortgage interest and we pay property taxes, it may not be enough for a single taxpayer to exceed $13,000 in the standard deduction. That's over $1,000 a month that you'd have to be paying between those two items. And at $90,000 taxable income, I would argue they're probably not in some home that has a half a million dollar mortgage that they just got, where they're paying so much in mortgage interest that they would be able to find enough expenses to exceed that standard deduction. And the ironic thing is that if.
[00:12:35] Speaker D: You'Re married, because for married couples who file jointly, that standard deduction raises from almost $14,000 to almost $28,000. It's an even higher bar to hit, not just in terms of the expenses associated with your home mortgage interest, property taxes and the like, but also your other deductions that you could itemize where you have to clear that $28,000 bar to justify listing them out, as opposed to just taking the standard option. But you don't have to take my word for it. Let's look at an example. If you're following along on screen, you're looking at something that's called a mortgage amortization schedule calculator. Put more simply, it is a schedule, year by year, of the amount of principal you would have paid off and the amount of interest you would have paid towards your mortgage over the course.
[00:13:22] Speaker A: Of the repayment period.
[00:13:24] Speaker D: In our example, we have a couple who has a $350,000 mortgage that they take out for 30 years at 6.5% interest. And we can actually look year by year and see how much they've paid in principal and interest. For example, if they started this mortgage in February of 2024, then over the course of the next twelve months, they would have paid down just $3,200 in principal from that original $350,000, and they would have paid $18,880 of interest in the first year. Now, to be clear, that's a significant amount of interest. But if they're going to claim that interest as an itemized deduction on their tax return, remember that they have to have enough other expenses elsewhere in their financial life to justify and clear the standard deduction, which is almost $28,000. So they've got almost $10,000 to go. Now, property taxes will help with that, because, remember, you can also deduct property taxes. But like I said, if they don't.
[00:14:27] Speaker A: Live in a state that has income.
[00:14:28] Speaker D: Taxes, they can't use income taxes.
[00:14:30] Speaker A: If they're in a position where they.
[00:14:32] Speaker D: Don'T have medical expenses that exceed 7.5%, they can't claim medical expenses.
[00:14:37] Speaker A: Maybe they give $100 a month or.
[00:14:39] Speaker D: So to charitable organizations, but there is no guarantee that they have enough other items that they can itemize to clear that standard deduction. And if they can't clear it, let's say that at the end of the day, they end up with only $25,000 of itemized deductions. That means that they would benefit by just not itemizing at all. And if that's the case, they wouldn't receive any of the tax favorability that people talk about when it comes to owning a home.
[00:15:07] Speaker A: When we get into rental real estate, that's a different story. But when people weigh the pros and cons of renting versus owning, they may say, oh, well, um, I'm renting for one, $800 a month or $2,000 a month, and my mortgage is going to be $2,100 a month. But I can deduct some of that mortgage interest, and I can deduct the property taxes that I pay. And when you look at the fact that I own the home, that's just so much better than throwing money away. Renting. Possibly it could be a benefit for other reasons, to go ahead and buy a home as compared to continuing to rent. But understand that as that standard deduction goes higher and higher, there's a larger and larger percentage of people in this country for whom it would benefit them to just take the standard deduction. And in that case, them being homeowners becomes irrelevant from a tax perspective. They're simply taking what's available to them, and they're not even utilizing the deduction that's available to the mortgage interest or property taxes that they pay each year. Now, for my family, it always makes sense to itemize. We are regular tithers and give offering to our local church. We give to charities throughout the year. And when you combine that with the benefits of being a homeowner, when it comes to the mortgage interest and my desire to just not be worried about some landlord increasing the rent every two or three years, we've decided that owning a home makes sense for us, and we always itemize our taxes because what we have available is greater than the standard deduction. But I hope this episode was helpful in illuminating the fact that it is not as black and white as, oh, I'm owning a home, I get tax deductions, versus I'm renting a home, and I don't get tax deductions. It's all about your specific scenario. And understanding how those things come into play can be helpful as you go through the thought process. If you're on the fence about buying versus staying put with a place that you may rent. See you next week.
[00:16:59] Speaker B: From new money new problems. This was the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen close.
