The debate over owning luxury real estate or renting it in Las Vegas has been going on for a long time and benefits (and disadvantages) keep on stacking for both sides. Here, we’ll discuss which side is better when it comes to tax deductions, with examples.
One of the main advantages you get from owning a house is the imputed rental income. This income isn’t taxed and is yours to keep. Furthermore as a homeowner, you may deduct any mortgage interest and property tax payable (and some other expenses) if you itemize other deductions. You also get to exclude the capital gain you get when selling the home.
On the other hand, one of the biggest tax benefits for renters is that if they freelance, they can deduct part of their rent expense against business-related expenses when filing returns.
It is no secret that the tax code favors homeowners than renters; which is a way of the government urging people to buy property. Let’s look at some of the tax deductions and their advantages home owners can enjoy against renting.
Home ownership is an investment that pays off in the form of you not having to pay rent. Since you now own property, in the eyes of the government you own a small portion of the country and therefore get to live free of cost (relatively). This is what we call “imputed rent”.
This rent is excluded from your taxable income. If you compare the same to renters or people who have rented their house out, they can’t exclude the same amount from their taxable income. As a homeowner, you become a landlord and a renter at the same time from the IRS’s point of view; just without any responsibilities.
According to the US Department of Treasury, excluded imputed rent amounted to $779 billion in 2018 and $984.4 billion in 2019.
Let’s say a family has bought luxury real estate in Las Vegas which would otherwise be rented at $5,000 a month. This would have been considered a rental expense for renters and taxable income for the landlord.
However, since you’re paying yourself $60,000 a year, by quite literally not doing anything, the same isn’t taxable. This is known as imputed rent.
Deduction of Mortgage Interest
Homeowners are allowed to itemize their deductions and therefore reduce tax liability (by reducing the taxable income). One way of doing that is by taking a sum of interest paid on your mortgage and deducting it from taxable income when filing.
Renters don’t have the same luxury of deducting interest expenses.
This deduction stemmed from the Tax Cuts and Jobs Act (TCJA), before which this deduction was applicable only on interest paid on debt for purchase of a home, up to $1 million. The debt had to be for home equity, but the funds could be used in any way after receiving the amount. Later on, this was changed to that funds need to be utilized only as home equity.
The OTA estimates that the mortgage interest deduction cost about $35.9 billion in 2020. This cost fell from 2018 ($74.5 billion) to 2020 because other previsions introduced by TCJA led to fewer taxpayers itemizing deductions.
Let’s say you have an outstanding mortgage balance and are looking to claim a mortgage interest deduction. Let’s assume you owe $500,000 against a mortgage on luxury real estate purchased in Las Vegas in 2018. Then, in 2020 you took another loan amounting to $300,000 as a home equity loan but used it to cover college expenses for your children and partially for home equity.
In this case, interest paid on the initial $500,000 will qualify for deduction, but only part of the second loan (that you used for home improvements of payments) will be deductible since the rest was used for other purposes.
Capital Gains From Sale of Property
We discussed how the sale of long-term property (or other capital assets) can help homeowners get a tax deductable. You can read more about that in our other blog, along with an example of the same.
There are several conditions that need to be fulfilled for an adjustable tax from capital gains from sale of property. These include:
- Homeowners may adjust up to $250,000 ($500,000 in case of joint filing) of capital gains if they resided in the house for 2 of the last 5 years and
- Must not have claimed capital gains exclusion for another capital asset in the last 2 years
Deduction of Property Tax
Homeowners also have the option of reducing their taxable income by adjusting property taxes applicable on their property, including luxury real estate in Las Vegas. This deduction basically acts like a transfer of what you paid to the federal government to state (or local) accounts that raise property taxes.
There is an overall cap of $10,000 ($5,000 if married and filing separately) on the tax which homeowners can deduct as dictated by TCIA. In 2019, this deductible saved homeowners across the US around $6 billion in income tax.
Let’s say that you’re married and taxable income before deduction amounted to $450,000 for 2020. During the year, you paid your mortgage ($40,000), donated to charity ($10,000), paid state income tax amounting to $25,000, and $15,000 as real estate taxes.
As we mentioned above, state and local tax (SALT) deductions have a maximum cap of $10,000, so your overall itemizable deduction will amount to $10,000; even though the above-mentioned deductibles exceed the amount.
The above mentioned tax advantages show that when it comes to tax, home ownership wins the debate of home ownership vs. renting.
Disclaimer: There are numerous factors to consider in every investment, including real estate. The information provided above is just a matter of opinion and can change with time. It shouldn’t be construed as legal or tax advice; neither does the report constitute a financial promotion or investment advice. It is general information and before making any such decision, you should seek out licensed professionals and see all ends clearly.