Tax deductions have a mythical quality. They are treasured. They are beloved. Some have legions of devoted followers. They seem larger-than-life, in a Texas kind of way.
But the ones we treasure and admire most – the mortgage interest and real estate tax deductions of home ownership – are far less valuable than most people believe.
If you live anywhere in Texas, this is true in spades. It was true in 2007 as we lurched into the real estate crash. And it is true today, even though home values in Texas have risen spectacularly.
A visit to Back Then
Historically, Texas has been a cheap place to live. In the late 1970s, for instance, Austin was routinely the lowest cost metropolitan area in the country. Later, at the height of the housing bubble in 2007, Austin, Dallas, Houston and San Antonio still had median home prices well below the national median.
It’s one of the reasons people move here.
Skeptical?
Here’s a list for 2007 with city median prices in Texas, also expressed as a percent of the national median.
— National median (Q3)$241,800 100.0%
— Austin $189,654 78.4%
— Dallas $167,240 69.2%
— Houston $158,390 65.6%
— San Antonio $151,343 62.6%
(Sources: Real Estate Center, Texas A&M, for August 2007) and FRED, St. Louis Federal Reserve Bank)
If most homes sell at prices below the national median, mortgages will be smaller. Which means interest payments will be lower. So unless you bought a relatively expensive home in Texas, odds were you wouldn’t have much to put on your list of itemized tax deductions.
The spreadsheet told me so
Back in 2007 I built a spreadsheet that estimated the tax benefit, year by year, for buying any particular home. The spreadsheet also cumulated the tax benefits and expressed the total as a percentage of the original purchase price.
In Austin — then and now the Texas city with the highest housing costs — the tax saving in the first year was a piddling $79. It shrank in the next two years as inflation increased the standard deduction. Then the benefits ended as the standard deduction exceeded the itemized deductions. The total tax benefit over three years was a piddling $129.
And that’s for the most expensive city in Texas.
(Note: The example here is for a joint return, not a single return, and doesn’t assume any other deductions such as those for charity or large medical expenses. It also assumes a 20 percent down payment and an interest rate of 6.37 percent in 2007. Then, as now, home ownership can be a better tax deal for singles because their standard deduction is half as large as the standard deduction for couples.)
What about now?
With Texas home values rising faster than many other areas of the country, Texans can have larger tax deductions because they pay more in interest and real estate taxes. But that possibility has been undone by the recent tax changes because they dramatically increased the standard deduction. The increase creates a higher threshold for enjoying any tax benefits from itemizing deductions.
Here’s the same price list for 2018:
—Austin $315,000 101.7%
—National Median (Q2) $309,800 100.0%
—Dallas $288,083 93.0%
—Houston $242,000 78.1%
—San Antonio $230,000 74.6%
(Note: the Houston figure is for July, other Texas figures for August)
As you can see, Austin is now more expensive than the national median. Other major Texas cities are closer to the national median than they were 11 years ago.
But guess what?
For most homebuyers in Texas the deductions for home mortgage interest and real estate taxes are still worth little, if anything. If a couple filing a joint return buys a median-priced Austin house, for instance, there will be no tax benefits.
Why? Their $24,000 standard deduction will exceed their itemized deductions.
Tax benefits for the truly desperate
So how can you enjoy a tax benefit from home ownership? There are two ways, both a bit desperate.
—Be single and stay single.With a lower standard deduction ($12,000 instead of $24,000), a single taxpayer will enjoy a first-year tax saving of about $1,575. That benefit will go on, at lower and lower amounts, for 17 years until it totals $15,246, or 4.8 percent of the original purchase price.
Like most of the laws that come out of Congress, a case can be made that “The Tax Cuts and Jobs Act” should have been called something else. I’d call it “The Cohabitation Encouragement Act” – at least where home ownership is concerned.
— Pay more for your house. Face it, the more you pay, the greater your tax and interest payments will be. But you’ll have to spend a lot to get any tax benefit. Worse, the tax benefit will always be less than your increased payments, a concept that many tax deduction fans don’t understand.
My calculations suggest that a couple will enjoy zero tax benefits until the purchase price exceeds about $405,000. At $410,000 it will be a one-time benefit of $39. After one year it disappears, swallowed up by an inflation-adjusted standard deduction.
What’s the bottom line? The tax incentive to pursue the dream of home ownership is mostly dead. Congress thinks renting is good, unless you are single.
Fortunately, there’s a happier way to think about it. I can see the billboards in California already.
Want an Easy Tax Return?
Move to Texas.
Data sources on the web:
The Real Estate Center at Texas A&M https://www.recenter.tamu.edu/data/housing-activity
30 Year Fixed Rate Mortgage Average in the United States, Fred Data https://fred.stlouisfed.org/graph/?g=NUh
Median home sale prices in the US, Fred Data https://fred.stlouisfed.org/series/MSPUS
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Acharaporn Kamornboonyarush from Pexels
(c) Scott Burns, 2018