Leverage, appreciation and tax breaks highlight the advantages of owning
real estate. Whether you are simply a homeowner or a real estate
investor, you benefit from owning property. The tax advantages of owning
real estate are one aspect of investing that transcends market
Mortgage Interest Deductions
As a homeowner, you are entitled to itemize your tax deductions and
claim all interest you pay on your mortgage as a deduction. In areas
characterized by high median home value, this benefit is especially
advantageous. If you are in a 28 percent tax bracket, buy a $700,000
condo in San Francisco with a 20 percent down payment and have a
$560,000 mortgage at 5 percent, your mortgage interest deduction during
your first year of home ownership will be just under $8,000 ($28,000 in
interest times .28). Use an online mortgage calculator with an
amortization schedule to calculate mortgage interest--it changes every
month because the principal is reduced. There are caps on the amount of
interest that can be written off and an income threshold beyond which
deductions are not allowed, but the vast majority of home owners never
butt up against these limitations.
Tax Exempt Profits
As a homeowner you are entitled to an exemption of $250,000 (if you are
single) or $500,000 (if you are married) of profit on your home when you
sell. You must live in your house at least two of the prior five years
before the sale. You can take advantage of this tax exemption once every
two years. If you are purchasing another house in the same region, you
may need the proceeds to purchase your next house, but if you are
downsizing or moving to a less-expensive area of the country, you will
be able to pocket the proceeds.
For rental property owners, depreciation is a significant tax benefit.
Depreciation is a deduction of the cost of buildings and capital
improvements to buildings over their lifetimes. The IRS has determined
the useful life of various classes of buildings and improvements. You
use these figures to determine how much of a deduction you can take each
year. If you buy an apartment building worth $1,000,000, you can deduct
$36,363 from the building's income each year for 27.5 years.
($1,000,000 divided by 27.5 years.) In some cases, depreciation results
in your making an actual cash profit but showing a paper loss for tax
purposes. In some instances, you can carry over excess depreciation to
reduce the tax liability of your employment income.
When you sell a rental property, you are entitled to take advantage of
IRS code No. 1031 and put the profits into a new building, tax free. The
1031 exchange can be used over and over, theoretically resulting in a
permanent avoidance of tax on your profits. You may also do a 1031
exchange and then refinance the new building, taking your profit out as
equity, tax free.