Mortgage Interest Deduction vs Standard Tax Deduction Question

[denefi]

Hi all,

I'm currently a renter and am trying to put together a break even analysis on when it would make more sense to purchase a small home or condo. Can someone let me know if I'm looking at this correctly? As I see it, the only interest deduction that should make a difference in my analysis is the marginal interest amount that puts me over the standard deduction of $6,100, taking into account other itemized deductions. I currently just take the the standard deduction.

So, assuming that I had $2,000 in other itemized deductions and paid $7,000 in mortgage interest, then the only amount of additional deduction that I would get is $2,900 ($7k+2k-6.1k=2.9k). Am I looking at this right?

Two quick additional questions - does property tax somehow get baked into your monthly payment, or is that just a yearly payment that you make? Also, are there any other deductions that I should be factoring in?

Thanks in advance!

denefi

 

[HFWR]

So, assuming that I had $2,000 in other itemized deductions and paid $7,000 in mortgage interest, then the only amount of additional deduction that I would get is $2,900 ($7k+2k-6.1k=2.9k). Am I looking at this right?

Correct, so, for instance, at the 25% tax bracket, you would save $225 in taxes over using the standard deduction.

Two quick additional questions - does property tax somehow get baked into your monthly payment, or is that just a yearly payment that you make?

Depends on how you set it up when you obtain the mortgage. You can pay property tax and homeowner's insurance as part of the payment, which is placed into an escrow account, and paid yearly by the holder of the note, or you can make the P&I payment only, and you mail your tax office and insurance company a separate check yearly.

 

[NW-Bound]

My experience is that the mortgage company generally wants to include tax and insurance in the monthly payment. That way, they can be sure that the house that they own actually gets insured, and will not get seized by the county for unpaid taxes.

When my house was paid for, the insurance and tax payments were taken care of by myself directly.

 

[denefi]

Great - thank you both for the quick response! This helps a lot.

 

[Ready]

Don't forget that property taxes paid are also deductible, just like interest. So your total savings should be higher after factoring in the property tax deductions.

 

[RunningBum]

Correct, so, for instance, at the 25% tax bracket, you would save $225 in taxes over using the standard deduction.

$2.9K @ 25% is a $725 tax break. Also, your property taxes are deductible.

Regarding property taxes, they were always included in my mortgage payment and held in escrow along with property insurance until the last mortgage I had, when I put > 20% down. For that one I made sure there was no PMI and I think I requested no escrow and paid taxes and insurance myself.

Also to consider when doing the breakeven analysis is the estimated cost of maintenance and repairs, the potential appreciation on the property, and future rent increases.

 

[2B]

Try to avoid escrow if you can. I've had mortgage companies in the past screw up the payments.

Another thing you can do if you don't escrow is bunch your property taxes (pay in Jan and Dec) and other controllable deductions. That maximizes your deductions every other year and you can take standard deductions the other year. This only works if you pay a significant amount of property tax.

 

[HFWR]

$2.9K @ 25% is a $725 tax break. Also, your property taxes are deductible.

Correct...

 

[Animorph]

Don't forget that property taxes paid are also deductible, just like interest. So your total savings should be higher after factoring in the property tax deductions.

And state income taxes if you have them.

 

[2B]

As a general comment, itemized deductions are a major point in the Washington tax discussions. Everything can change next year.

 

[frayne]

As a general rule any time your itemized deduction is higher than your standard deduction, that is the best way to go. One caveat is if you live in a state that has state income tax, sometimes you are better off taking the standard deduction in order to get a better refund or lower tax liability on your state tax. This usually happens if your itemized deductions are just a little bit higher than the standard deduction. Hope this isn't too confusing.

Also when you itemize you can take credit for PMI, state income or sales tax, charitable contributions/mileage, medical expenses/mileage in excess of 10% of your AGI, gambling losses to the point of offsetting gambling winnings and in some cases education expenses in excess of 2% of your AGI under misc. deductions.

 

[M Paquette]

As a general comment, itemized deductions are a major point in the Washington tax discussions. Everything can change next year.

Nah. There won't be significant changes before 2017. Next year is mid-term elections. Don't want to rock the boat. In 2015 we seat a 'new' Congress, which will be busy with reassigning committee seats before they even begin holding hearings on potential policy changes. In mid 2015, the presidential campaign season starts up (Eccch!), and "don't rock the boat" becomes very important. This continues through 2016, with much bloviating, promises made, and of course, no action taken. The only time anything significant can change is in the first year of the first term of a new president. Outside that time frame very little happens legislatively.

So, for tax planning purposes, "Keep on keeping on". Surprises are unlikely.

 

[frayne]

Nah. There won't be significant changes before 2017. Next year is mid-term elections. Don't want to rock the boat. In 2015 we seat a 'new' Congress, which will be busy with reassigning committee seats before they even begin holding hearings on potential policy changes. In mid 2015, the presidential campaign season starts up (Eccch!), and "don't rock the boat" becomes very important. This continues through 2016, with much bloviating, promises made, and of course, no action taken. The only time anything significant can change is in the first year of the first term of a new president. Outside that time frame very little happens legislatively.

So, for tax planning purposes, "Keep on keeping on". Surprises are unlikely.

+1, too many political hot potatoes. You may see a few small teaks but nothing major will change.

 

[denefi]

Thanks all. Am I right that traditional IRA contributions are deducted toward the 6k, whereas pretax 401k contributions are not? If so, seems it would make sense to shift some of my retirement contributions from the 401k to an IRA so that all mortgage insurance would be deductible. Is this sound thinking? Seeing if I should factor this in.

 

[RunningBum]

What 6K are you talking about? Standard deduction? IRA's aren't on Schedule A if that's the case, so no, that doesn't make sense. I find it easiest to model such things with Turbo Tax. If you used it in the past, just copy your last return to a new file and make whatever changes you want to see the effect of.

 

[kaneohe]

I'm also confused about the 6K...........but I'm guessing OP thinks that an IRA deduction might be more beneficial than a 401K contribution. I'm guessing also that there may be a misunderstanding of how things work.
1) 401K contribution e.g. of 5K. If your gross salary is 50K and you make a 5K 401K contribution, your W2 federal gross wages will be reported as 45K. A 401K is sometimes called a salary reduction plan.
2) TIRA contribution of 5K instead of 401K. Your federal gross wages will be reported as 50K and with your IRA deduction or 5k, your gross income will be 45K..........the same as in case 1). In fact under certain conditions, the TIRA deduction may be phased out or not allowed so generally, the 401K contribution may be better. Technically the IRA deduction is an adjustment to income, not a deduction.

 

[denefi]

What 6K are you talking about? Standard deduction? IRA's aren't on Schedule A if that's the case, so no, that doesn't make sense. I find it easiest to model such things with Turbo Tax. If you used it in the past, just copy your last return to a new file and make whatever changes you want to see the effect of.

Sorry, I was referring to the standard deduction. Gotcha. I used Turbotax last year so I'll try to play around with it.

I'm also confused about the 6K...........but I'm guessing OP thinks that an IRA deduction might be more beneficial than a 401K contribution. I'm guessing also that there may be a misunderstanding of how things work.
1) 401K contribution e.g. of 5K. If your gross salary is 50K and you make a 5K 401K contribution, your W2 federal gross wages will be reported as 45K. A 401K is sometimes called a salary reduction plan.
2) TIRA contribution of 5K instead of 401K. Your federal gross wages will be reported as 50K and with your IRA deduction or 5k, your gross income will be 45K..........the same as in case 1). In fact under certain conditions, the TIRA deduction may be phased out or not allowed so generally, the 401K contribution may be better. Technically the IRA deduction is an adjustment to income, not a deduction.

Makes sense, thanks!