Is Your House a Good Place to Park Your Wealth? Is it Tax Favorable?

???????????????????????????????????????Is your wealth in the house (equity) receiving favorable tax treatment? To answer that question you must first understand what we mean by favorable tax treatment. Let’s define tax treatment as the method of taxation the principal and/or growth could potentially be subject to. Understanding the tax treatment of an investment is vitally important because taxes can have a critical impact on your ability to create and grow your wealth.

The wealth in your house (equity) potentially benefits from two types of tax treatment. The first is the homestead exemption, depending on the state you live in, which provides a benefit during the time you occupy your primary residence. In California, the homestead exemption protects a person or family’s primary residence from a forced sale to pay certain types of creditors. The amount of wealth in the house protected from judgment creditors is as follows:

Homestead Exemption Amounts

For example, let’s say your house is currently valued at $450,000 and you have a mortgage of $300,000. Your wealth in the house is $150,000. According to the homestead laws in California, as a married couple, only $100,000 of the wealth in your house is protected, which means you may be forced to sell your home to satisfy a judgment for up to $50,000. You should verify the homestead laws in your state of residence to determine the level of protection provided for the wealth in your house.

tax-capital-gainsThe second is the capital gains tax exemption, which protects your capital gain (profit) at the time you sell your primary residence. The capital gains tax exemption can represent a significant tax savings at the time of sale. Under Section 121 of the IRS Code, and spelled out in IRS Publication 523 (2013), homeowners who sell their primary residence may be able to exclude from income any gain up to a limit of $500,000 if the homeowner is married and files a joint tax return. The limit is $250,000 for a single income tax filer or a married couple filing separately. In a post entitled “How Can the Tax Treatment of Real Estate Save a Seller Thousands of Dollars?“ I explain in detail how the capital gains tax exemption works.

However, while it doesn’t protect the wealth in the house, it is the mortgage interest deduction that provides the most favorable tax treatment, and while every principal payment you make decreases your mortgage balance and the interest that you pay to the mortgage company, it increases the tax you pay.

Deduct mortgage interest on taxesUnder Section 163 of the IRS code, and spelled out in IRS Publication 936 (2013), interest on loans used to acquire, construct, or substantially improve a qualified home, known as acquisition debt, is deductible on up to a $1 million mortgage amount. Interest on loans used for any purpose, known as home equity debt, is deductible on up to a $100,000 mortgage amount, for a total mortgage amount of $1,100,000. In other words, every dollar a homeowner pays in mortgage interest on a mortgage amount of up to $1.1 million is tax deductible in the year paid, unless the homeowner’s income is greater than the income limitations placed on itemized deductions and they are phased-out. A qualified home is defined as both a primary and secondary residence. In a post entitled “How Can Itemizing Deductions Affect a Homeowner’s Income Taxes?” I explain in detail how the mortgage interest deduction works.

We believe the wealth in your house (equity), and real estate as a whole, receives very favorable tax treatment!

If you’re interested in learning more about the house as an investment and how owning a house can help you grow your wealth contact us to schedule a time to talk about your specific circumstances.

There are a number of caveats to the homestead law and the capital gains tax exemption mentioned above, which are beyond the scope of this blog post. This blog post is intended to provide introductory information to the subject matter covered. Neither the company, the advisor, nor their representatives offer tax or legal advice. Consult your attorney or tax advisor as to the applicability of this information to your specific circumstances and for complete up-to-date information concerning federal and state laws in this area.

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