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I've heard that some people buy a more expensive house as a tax shelter. In my simple mind I imaging the scenario:

  • Pay 10,000 annual interest on the mortgage
  • 50,000 annual income

= 40,000 taxable income.

So I can choose to payoff the mortgage. Then, I am taxed on 50,000 income. But, I have 10,000 dollars more buying power which I could choose to invest in something.

I mean, while paying taxes is no fun. Does it make sense to buy a bigger house as a tax shelter?

Location: USA, Dallas TX

  • 8
    For the sake of your finances, if you got this information from a realtor, fire them now – Mike Pennington Jan 10 '12 at 10:46
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    If nothing else you are ignoring the fact that a larger house will cost you more in property tax, maintenance, heating, furnishing etc, and will take you more time to clean and look after. – DJClayworth Jan 10 '12 at 14:25
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    @Mike: Agreed. After the events of the last decade, anyone who tells you to buy a house as an investment of any kind oughtta be taken out and shot. – Mason Wheeler Jan 10 '12 at 17:26
  • @MasonWheeler - A guy I really respect has a similar sentiment. I'm not sure I agree. The statistics I've seen clearly demonstrate homeowners net-worth far exceeds that of renters. IMO, this is because rent money is not recoverable. A house is an asset. – P.Brian.Mackey Sep 20 '14 at 0:44
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    @P.Brian.Mackey: I didn't say people shouldn't be homeowners; that's something completely different. I said buying houses as investments (not as homes) is both stupid and reckless, as evidenced by the events of the last decade. – Mason Wheeler Sep 21 '14 at 1:15
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No. This logic is dangerous.

The apples to apples comparison between renting and buying should be between similar living arrangements. One can't (legitimately) compare living in a 600 sq ft studio to a 3500 sq ft house.

With the proposal you offer, one should get the largest mortgage they qualify for, but that can result in a house far too big for their needs. Borrowing to buy just what you need makes sense. Borrowing to buy a house with rooms you may never visit, not a great idea.

By the way, do the numbers. The 30 year rate is 4%. You'd need a $250,000 mortgage to get $10,000 in interest the first year, that's a $312,000 house given an 80% loan. On a median income, do you think it makes sense to buy a house twice the US median?

Last, a portion of the tax savings is 'lost' to the fact that you have a standard deduction of nearly $6,000 in 2012. So that huge mortgage gets you an extra $4000 in write-off, and $600 back in taxes.

Don't ever let the Tax Tail wag the Investing Dog, or in this case the House Dog.

Edit - the investment return on real estate is a hot topic. I think it's fair to say that long term one must include the rental value of the house in calculating returns. In the case of buying of way-too-big house, you are not getting the return, it's the same as renting a four bedroom, but leaving three empty. If I can go on a bit - I own a rental, it's worth $200K and after condo fee and property tax, I get $10K/yr. A 5% return, plus whatever appreciation. Now, if I lived there, I'd correctly claim that part of my return is the rental value, the rent I don't pay elsewhere, so the return to me is the potential growth as well as saved rent. But if the condo rents for $1200, and I'd otherwise live in a $600 apartment with less space, the return to me is lost. In my personal case, in fact, I bought a too big house. Not too big for our paycheck, the cost and therefore the mortgage were well below what the bank qualified us for. Too big for the need. I paid for two rooms we really don't use.

  • Thanks for the vote +1 to you as well. At first I thought your answer might be a little too negative, but the more I think about the more I think your dog expression is exactly right. – Pablitorun Jan 9 '12 at 18:32
  • +1 - Not to mention extra property tax on a home that size will probably eat up any money you save on the mortgage. And in time a bigger house is more expenses in upkeep. You will never come out ahead spending more than you can really afford. – user4127 Jan 9 '12 at 21:58
  • +1, great advice. However I'd just like to comment that in some areas (typically those with very expensive housing), you usually can find tenants to rent out part of your house, while you live in it. So it's not the case that the "too big" space is always wasted. Of course, in most areas of the country this isn't really viable, and having live-in tenants is a big sacrifice. – TM. Jan 15 '12 at 3:50
  • @TM - one of the best deals I ever saw was a woman who rented the two extra bedrooms in her house. She used the money to pay it off in record time. So I'm with you. It's a great bit of advice to the question, but it's not about big house for the deduction, it's about being a landlord. – JoeTaxpayer Jan 15 '12 at 4:14
  • @JoeTaxpayer -- Though being a landlord has its obligations and hassles along with its income and deductability benefits. I have friends who've made it work for decades; I have friends who have looked at it and decided they really couldn't cope. Interesting idea but definitely Not For Everyone. (Not for me -- one of my reasons for buying was better sound isolation from my neighbors.) – keshlam Jul 27 '14 at 5:05
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Two points

  1. You don't really get the full 10,000 annual interest as tax free income. Well you do, but you would have gotten a substantial amount of that anyway as the standard deduction.

    ...From the IRS.... Standard deduction The standard deduction for married couples filing a joint return is at $11,900 for 2012. The standard deduction for single individuals and married couples filing separate returns is $5,950 for 2012. The standard deduction for heads of household increases by $50 to $8,700 for 2012.

    so If you were married it wouldn't even make sense to claim the 10,000 mortgage interest deduction as the standard one is larger.

  2. It can make sense to do what you are talking about, but ultimately you have to decide what the effective interest rate on your mortgage is and if you can afford it.

    For instance. I might have a 5% mortgage. If I am in a 20% tax bracket it effectively is a 4% mortgage to me. Even though I am saving tax money I am still paying effectively 4%. Ultimately the variables are too complex to generalize any hard and fast rules, but it often times does make sense.

(You should also be aware that there has been some talk of eliminating or phasing out the mortgage interest deduction as a way to close the deficit and reduce the debt.)

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    +1 - you hit the high points perfectly, we overlapped a bit. Updated your numbers to reflect 2012, by the way. – JoeTaxpayer Jan 9 '12 at 17:02
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Depending on the state you live in paying interest on a mortgage opens up other tax deduction options: Real estate taxes, Car tax, donations. See schedule A http://www.irs.gov/pub/irs-pdf/f1040sa.pdf

The shocking bottom line is that it never works to your advantage in the short term.

Owning your house:

  • lets you paint it any color you want, rip out walls...
  • avoid some of the yearly increase in rent.
  • convert some hidden deductions.
  • gives you a chance to make a profit when you sell.

But there are big risks, ask anybody stuck with a house they can't sell.

But it doesn't scale. You spend 10K more to save 2.5K in taxes. Buy because you want to, not to reduce taxes.

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