The most common type of real estate investment is home ownership, which generally also accounts for the largest single investment made by many families.
Home Ownership
The purchase of a home might be the largest single expenditure that you make, but this expenditure differs from other expenditures that you make. Few people have enough cash to pay the entire cost of the home. Instead, they make a down payment and borrow the balance from a financial institution using the home as collateral on the mortgage loan. Securing a mortgage loan from a financial lender requires that the borrower has the financial means to be able to repay monthly amounts of interest and principal, as well as to be able to cover insurance, real estate taxes, and maintenance on the property. Home ownership offers significant tax benefits and opportunities to increase wealth and capital appreciation. Over long periods, most homes appreciate in value, and prices tend to keep up with inflation. Tax benefits come from being able to deduct both interest expenses on the home mortgage and real estate taxes from taxable income at the federal level. These deductions result in lowering taxable income and taxes paid to the federal government. In addition, interest expense on a home mortgage is not subject to inclusion in the computation of the alternative minimum tax (AMT). Because a portion of each monthly mortgage payment is applied to the repayment of the mortgage loan, the home owner is reducing the mortgage balance with each monthly payment and increasing his or her equity position, which is another form of saving.
The disadvantage of home ownership is that if house prices decline and you have to sell your house when the property market is depressed, you could end up losing money. Home ownership also can decrease your mobility in that it might not be easy to sell your home and move to another location in a short period of time.
Income Tax Benefits
Interest paid on a home mortgage loan is a tax-deductible expense, that reduces taxable income at the federal level, thereby resulting in savings on taxes paid. For example, in the taxable year, if interest on a home loan mortgage is $12,000, taxable income is reduced by this amount. Consequently, the effective rate of the cost of the home loan is reduced by the tax saving:
Effective interest cost = mortgage rate X (1 - marginal tax rate)
For example, an investor in the 35 percent marginal tax bracket with a 6 percent mortgage loan has an effective (after tax) rate of 3.9 percent on the mortgage loan.
Effective interest cost = 0.06 X (1 - 0.35) = 0.039
The second tax benefit to home ownership is the deductibility gains tax results in an increased return on after-tax profits from the sale of a principal residence when compared with the sale of other investments such as stocks and bonds.
These tax benefits generally make it advantageous to buy a home rather than rent. There are times, however, when it becomes advantageous to rent rather than buy. of property taxes on the home, which reduces taxable income and taxes paid.
The third tax benefit from home ownership occurs when the home is sold. The profit on the sale of a principal residence is not taxable if the gain is less than $250,000 for a tax payer filing a single return and $500,000 for a taxpayer filing a joint return. To qualify for this exclusion from capital gains taxes, the homeowner must have lived in the home for at least two of the five years, and the exclusion applies to only one sale every two years. Home prices have risen over the past 50 years. Consequently, this exclusion from capital
